10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2007

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 1-10777

Ambac Financial Group, Inc.

(Exact name of Registrant as specified in its charter)

Delaware	13-3621676
(State of incorporation)	(I.R.S. employer identification no.)

One State Street Plaza New York, New York	10004
(Address of principal executive offices)	(Zip code)

(212) 668-0340

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act): (Check one):

Large accelerated filer  x Accelerated filer  ¨ Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of August 2, 2007, 101,513,708 shares of Common Stock, par value $0.01 per share, (net of 7,679,388 treasury shares) of the Registrant were outstanding.

Ambac Financial Group, Inc. and Subsidiaries

INDEX

		PAGE
PART I     FINANCIAL INFORMATION
Item 1.	Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
	Consolidated Balance Sheets – June 30, 2007 (unaudited) and December 31, 2006	3
	Consolidated Statements of Operations (unaudited) – three and six months ended June 30, 2007 and 2006	4
	Consolidated Statements of Stockholders’ Equity (unaudited) – six months ended June 30, 2007 and 2006	5
	Consolidated Statements of Cash Flows (unaudited) – six months ended June 30, 2007 and 2006	6
	Notes to Unaudited Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	51
Item 4.	Controls and Procedures	56
PART II     OTHER INFORMATION
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 4.	Submission of Matters to a Vote of Security Holders	58
Item 6.	Exhibits	59
SIGNATURES		60
INDEX TO EXHIBITS		61

PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements of Ambac Financial Group, Inc. and Subsidiaries

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

June 30, 2007 and December 31, 2006

(Dollars in Thousands)

	June 30, 2007			December 31, 2006
	(unaudited)
Assets
Investments:
Fixed income securities, at fair value (amortized cost of $17,265,975 in 2007 and $16,484,257 in 2006)	$	17,385,817		$	16,800,338
Fixed income securities pledged as collateral, at fair value (amortized cost of $293,935 in 2007 and $311,546 in 2006)		285,605			307,101
Short-term investments, at cost (approximates fair value)		291,979			311,759
Other (cost of $38,669 in 2007 and $13,427 in 2006)		39,928			14,391
Total investments		18,003,329			17,433,589
Cash		35,729			31,868
Securities purchased under agreements to resell		270,000			273,000
Receivable for securities sold		48,979			12,857
Investment income due and accrued		183,207			193,199
Reinsurance recoverable on paid and unpaid losses		4,793			3,921
Prepaid reinsurance		322,914			315,498
Deferred acquisition costs		271,235			252,115
Loans		861,364			625,422
Derivative assets		939,658			1,019,339
Other assets		120,533			107,005
Total assets	$	21,061,741		$	20,267,813
Liabilities and Stockholders’ Equity
Liabilities:
Unearned premiums	$	3,061,673		$	3,037,544
Loss and loss expense reserve		255,825			220,074
Ceded reinsurance balances payable		19,198			20,084
Obligations under investment and payment agreements		8,395,689			8,202,590
Obligations under investment repurchase agreements		135,465			154,287
Deferred income taxes		183,117			263,483
Current income taxes		49,227			49,920
Long-term debt		1,664,705			991,804
Accrued interest payable		93,855			105,129
Derivative liabilities		675,290			667,066
Other liabilities		317,018			275,670
Payable for securities purchased		168,850			95,973
Total liabilities		15,019,912			14,083,624
Stockholders’ equity:
Preferred stock		—			—
Common stock		1,092			1,092
Additional paid-in capital		829,853			790,168
Accumulated other comprehensive income		69,341			197,576
Retained earnings		5,773,888			5,454,575
Common stock held in treasury at cost		(632,345	)		(259,222	)
Total stockholders’ equity		6,041,829			6,184,189
Total liabilities and stockholders’ equity	$	21,061,741		$	20,267,813

See accompanying Notes to Unaudited Consolidated Financial Statements

3

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

For the Three and Six Months Ended June 30, 2007 and 2006

(Dollars in Thousands Except Share Data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
Revenues:
Financial Guarantee:
Gross premiums written	$	261,139		$	313,500		$	511,051		$	532,558
Ceded premiums written		(28,437	)		(57,747	)		(57,921	)		(48,990	)
Net premiums written	$	232,702		$	255,753		$	453,130		$	483,568
Net premiums earned	$	221,019		$	210,829		$	437,025		$	405,061
Other credit enhancement fees		17,332			14,155			32,885			28,343
Net premiums earned and other credit enhancement fees		238,351			224,984			469,910			433,404
Net investment income		113,190			104,455			225,254			206,189
Net realized investment gains		881			1,892			1,321			1,513
Net mark-to-market (losses) gains on credit derivative contracts		(56,867	)		5,381			(61,991	)		7,334
Other income		5,649			3,453			8,505			32,415
Financial Services:
Investment income		107,903			98,048			213,873			179,983
Derivative products		2,464			3,321			6,070			8,007
Net realized investment gains		310			41,728			6,471			47,231
Net mark-to-market (losses) gains on total return swap contracts		(982	)		1,818			2,233			7,041
Net mark-to-market gains (losses) on non-trading derivatives		340			(306	)		(159	)		(62	)
Corporate:
Net investment income		1,341			3,396			2,922			6,396
Net realized investment gains		—			791			—			791
Total revenues		412,580			488,961			874,409			930,242
Expenses:
Financial Guarantee:
Loss and loss expenses		17,096			12,822			28,518			12,949
Underwriting and operating expenses		33,438			31,865			69,814			69,723
Financial Services:
Interest on investment and payment agreements		101,124			90,533			200,082			165,498
Operating expenses		3,117			3,303			6,405			6,875
Interest		22,091			19,475			41,380			38,950
Corporate		3,664			4,000			6,920			7,643
Total expenses		180,530			161,998			353,119			301,638
Income before income taxes		232,050			326,963			521,290			628,604
Provision for income taxes		59,013			88,393			134,910			168,894
Net income	$	173,037		$	238,570		$	386,380		$	459,710
Net income per share	$	1.69		$	2.24		$	3.73		$	4.32
Net income per diluted share	$	1.67		$	2.22		$	3.70		$	4.28
Weighted average number of common shares outstanding:
Basic		102,557,554			106,485,245			103,600,542			106,462,001
Diluted		103,442,086			107,450,639			104,550,048			107,398,480

See accompanying Notes to Unaudited Consolidated Financial Statements

4

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

For The Six Months Ended June 30, 2007 and 2006

(Dollars in Thousands)

	2007						2006
Retained Earnings:
Balance at January 1	$	5,454,575					$	4,703,256
Net income		386,380		$	386,380			459,710		$	459,710
Dividends declared—common stock		(36,919	)					(31,733	)
Dividends on restricted stock units		(5	)					(390	)
Exercise of stock options		(30,143	)					(37,240	)
Balance at June 30	$	5,773,888					$	5,093,603
Accumulated Other Comprehensive Income:
Balance at January 1	$	197,576					$	202,312
Unrealized losses on securities, ($199,828) and ($264,022), pre-tax in 2007 and 2006, respectively(1)					(127,801	)					(165,857	)
(Loss) gain on derivative hedges, ($3,346) and $2,768, pre-tax in 2007 and 2006, respectively					(2,183	)					1,549
Foreign currency translation gain					1,749						4,319
Other comprehensive loss		(128,235	)		(128,235	)		(159,989	)		(159,989	)
Comprehensive income				$	258,145					$	299,721
Balance at June 30	$	69,341					$	42,323
Preferred Stock:
Balance at January 1 and June 30	$	—					$	—
Common Stock:
Balance at January 1 and June 30	$	1,092					$	1,092
Additional Paid-in Capital:
Balance at January 1	$	790,168					$	723,680
Share-based compensation		31,104						12,175
Excess tax benefit related to share-based compensation		8,581						9,482
Balance at June 30	$	829,853					$	745,337
Common Stock Held in Treasury at Cost:
Balance at January 1	$	(259,222	)				$	(247,578	)
Cost of shares acquired		(428,886	)					(43,799	)
Shares issued under equity plans		55,763						49,798
Balance at June 30	$	(632,345	)				$	(241,579	)
Total Stockholders’ Equity at June 30	$	6,041,829					$	5,640,776
(1) Disclosure of reclassification amount:
Unrealized holding losses arising during period	$	(126,998	)				$	(165,360	)
Less: reclassification adjustment for net gains included in net income		803						497
Net unrealized losses on securities	$	(127,801	)				$	(165,857	)

See accompanying Notes to Unaudited Consolidated Financial Statements

5

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

For The Six Months Ended June 30, 2007 and 2006

(Dollars in Thousands)

	Six Months Ended June 30,
	2007			2006
Cash flows from operating activities:
Net income	$	386,380		$	459,710
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization		1,347			1,431
Amortization of bond premium and discount		1,085			1,136
Share-based compensation		24,098			13,471
Current income taxes		(693	)		70,968
Deferred income taxes		(8,121	)		(30,122	)
Deferred acquisition costs		(12,672	)		(9,003	)
Unearned premiums, net		16,713			80,003
Loss and loss expenses		34,879			(14,662	)
Ceded reinsurance balances payable		(886	)		14,334
Investment income due and accrued		9,992			(3,694	)
Accrued interest payable		(11,274	)		(29,813	)
Change in trading account assets		(25,195	)		-
Net mark-to-market losses (gains)		59,917			(14,313	)
Net realized investment gains		(7,792	)		(49,535	)
Other, net		(23,585	)		62,530
Net cash provided by operating activities		444,193			552,441
Cash flows from investing activities:
Proceeds from sales of bonds		225,794			753,837
Proceeds from matured bonds		909,201			1,062,140
Purchases of bonds		(1,861,092	)		(3,312,989	)
Change in short-term investments		19,780			230,236
Securities purchased under agreements to resell		3,000			219,000
Loans, net		(235,942	)		36,471
Recoveries from impaired investments		6,206			44,146
Other, net		(3,201	)		11,171
Net cash used in investing activities		(936,254	)		(955,988	)
Cash flows from financing activities:
Dividends paid		(36,919	)		(31,733	)
Securities sold under agreements to repurchase		-			20,000
Proceeds from issuance of investment and payment agreements		928,595			1,306,179
Payments for investment and payment agreement draws		(745,903	)		(877,704	)
Proceeds from the issuance of long-term debt		668,830			-
Capital issuance costs		(1,685	)		(1,865	)
Net cash collateral received		77,692			14,191
Purchases of treasury stock		(428,886	)		(43,799	)
Proceeds from sale of treasury stock		25,618			12,655
Excess tax benefit related to share-based compensation		8,580			9,482
Net cash provided by financing activities		495,922			407,406
Net cash flow		3,861			3,859
Cash at January 1		31,868			27,619
Cash at June 30	$	35,729		$	31,478
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes	$	136,084		$	118,235
Interest on long-term debt	$	32,483		$	48,528
Interest on investment agreements	$	201,201		$	154,790

See accompanying Notes to Unaudited Consolidated Financial Statements

6

Ambac Financial Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands)

(1) Background and Basis of Presentation

Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose subsidiaries provide financial guarantee products and other financial services to clients in both the public and private sectors around the world. Ambac’s principal operating subsidiary, Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch Inc. Financial guarantee insurance provides an unconditional and irrevocable guarantee that protects the holder of a fixed income obligation against non-payment of principal and interest when due. Essentially, Ambac Assurance makes payment if the obligor responsible for making payments fails to do so. A bond guaranteed by Ambac Assurance receives triple-A ratings, typically resulting in lower financing costs for the issuer and the guarantee generally makes the issue more marketable, both in the primary and secondary markets. Ambac’s financial strength ratings are an essential part of Ambac Assurance’s ability to provide credit enhancement and any reduction in these ratings could have a materially adverse affect on Ambac Assurance’s ability to compete in the financial guarantee business. Ambac Assurance provides financial guarantees for bond issues and other forms of debt financing. As an alternative to financial guarantee insurance, credit protection relating to a particular pool of assets, security or issuer can be provided through a credit derivative. Ambac provides credit protection in the global markets in credit derivative form.

Ambac’s consolidated unaudited interim financial statements have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”) and, in the opinion of management, reflect all adjustments necessary for a fair presentation of Ambac’s financial condition, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the six months ended June 30, 2007 may not be indicative of the results that may be expected for the full year ending December 31, 2007. These consolidated financial statements and notes should be read in conjunction with the financial statements and notes included in (i) Ambac’s Annual Report on Form 10-K for the year ended December 31, 2006, which was filed with the Securities and Exchange Commission on March 1, 2007, and (ii) Ambac’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007, which was filed with the SEC on May 10, 2007.

The consolidated financial statements include the accounts of Ambac and all other entities in which Ambac has a controlling financial interest. All significant intercompany balances have been eliminated. The usual condition for a controlling financial interest is ownership of a majority of the voting interests of an entity. However, a controlling financial interest may also exist in entities, such as variable interest entities (“VIEs”), through arrangements that do not involve controlling voting interests. Certain reclassifications have been made to prior periods’ amounts to conform to the current period’s presentation.

7

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

(2) Net Premiums Earned

Gross premiums are received either upfront (typical of public finance obligations), or in installments (typical of structured finance obligations). Up-front insurance premiums written are received for an entire bond issue, which may contain several maturities; and are recorded as unearned premiums. The premium is allocated to each bond maturity proportionately based on total principal amount guaranteed and is recognized as premiums on a straight-line basis over the term of each maturity. Installment insurance premiums written are recognized as premiums earned over each installment period, typically one year or less, on a straight-line basis. Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. When an issue insured by Ambac Assurance has been refunded or called, the remaining unrecognized premium (net of refunding credits, if any) is recognized at that time.

Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies. For both up-front and installment premiums, ceded premiums written are primarily recognized in earnings in proportion to and at the same time the related gross premium revenue is recognized. Prepaid reinsurance represents the portion of premiums ceded to reinsurers relating to unearned premiums ceded under reinsurance contracts. As discussed in footnote 9, the accounting for premiums earned is subject to change.

(3) Loss and Loss Expenses

The loss reserve policy for financial guarantee insurance discussed in this footnote relates only to Ambac’s non-derivative insurance business. The policy for derivative contracts is discussed in Note (4) “Derivative Contracts”. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. In most instances, claim payments are forecasted in advance of issuer default as a result of active surveillance of the insured book of business and observation of deterioration in the obligor’s credit standing. Based upon Ambac’s experience, claim payments become probable and estimable once the issuer’s credit profile has migrated to certain impaired credit levels. The trustee, on behalf of the insured party, named beneficiary, or custodian has the right to make a claim under Ambac’s financial guarantee insurance policy at the first scheduled debt service date of the defaulted obligation. As discussed in the last paragraph of this Note, the accounting for credit loss reserves is subject to change.

The liability for losses and loss expenses consists of active credit and case basis credit reserves. Active credit reserves are for probable and estimable losses due to credit deterioration on insured credits that have not yet defaulted or been reported and are reflected on an undiscounted basis as of the reporting date. The establishment of reserves for exposures that have not yet defaulted is a common practice in the financial guarantee industry. However, Ambac is aware that there are differences in the specific methodologies applied by other financial guarantors in establishing such reserves. Ambac’s active credit reserve is based on management’s on-going review of the non-derivative financial guarantee credit portfolio. Active surveillance of the insured portfolio enables Ambac’s Surveillance Group to track credit migration of insured obligations from period to period and prepare an adversely classified credit listing. The active credit reserve is established only for adversely classified credits. The criteria for an

8

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

exposure to be included on the adversely classified credit listing includes the deterioration in an issuer’s financial condition, underperformance of the underlying collateral (for collateral dependent transactions such as mortgage-backed securitizations), problems with the servicer of the underlying collateral and other adverse economic events or trends. The servicer of the underlying collateral of an insured securitization transaction is a consideration in assessing credit quality because the servicer’s performance can directly impact the performance of the related issue. For example, a servicer of a mortgage-backed securitization that does not remain current in its collection efforts could cause an increase in the delinquency and potential default of the underlying obligation.

The active credit reserve is established through a process that begins with estimates of probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac’s internal system of credit ratings, which are analogous to the risk ratings of the major rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) the net par outstanding on the adversely classified credit. The loss severities and default information are based on rating agency information and are specific to each bond type and are established and approved by Ambac’s Portfolio Risk Management Committee. The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac. For certain adversely classified credit exposures, Ambac’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities applied to adversely classified credits can include various actions by Ambac. The most common actions include obtaining detailed appraisal information on collateral, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical approach discussed above. Senior management meets at least quarterly with the Surveillance Group to review the status of their work to determine the adequacy of Ambac’s loss reserves and make any necessary adjustments. Active credit reserves were $203,707 and $172,644 at June 30, 2007 and December 31, 2006, respectively. The active credit reserves at June 30, 2007 and December 31, 2006 were comprised of 46 credits with net par of $3,223,583 and 55 credits with net par outstanding of $3,830,759, respectively. Included in the calculation of active credit reserves at June 30, 2007 and December 31, 2006 was the consideration of $11,875 and $6,859, respectively, of reinsurance which would be due to Ambac from reinsurers, upon default of the insured obligation.

Case basis credit reserves are for losses on insured obligations that have defaulted. We believe our definition of case basis credit reserves differs from other financial guarantee industry participants. Upon the occurrence of a payment default, the related active credit reserve is transferred to case basis credit reserve. Additional provisions for losses upon further credit deterioration of a case basis exposure are initially recorded through the active credit reserve and subsequently transferred to case basis credit reserves. Our case reserves represent the present value of anticipated loss and loss expense payments expected over the estimated period of default. Loss and loss expenses consider anticipated defaulted debt service payments, estimated expenses associated with settling the claims and estimated recoveries under collateral and subrogation rights. The estimate does not consider future installment premium receipts, as the likelihood of such receipts is remote. Ambac discounts these estimated net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio.

9

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

Case basis credit reserves were $52,118 and $47,430 at June 30, 2007 and December 31, 2006, respectively. The discount rate applied to case basis credit reserves was 4.50% at June 30, 2007 and December 31, 2006. The case basis credit reserves at June 30, 2007 and December 31, 2006 were comprised of 7 credits, with net par outstanding of $495,182 and $668,440, respectively. Additionally, we have reinsurance recoverables on case basis credit reserves of $4,857 and $4,972 at June 30, 2007 and December 31, 2006, respectively.

Ambac provides information on the classification of its loss reserve between active credit reserve and case basis credit reserve for the purpose of disclosing the components of the total reserve that relate to exposures that have not yet defaulted and those that have defaulted. The total reserve (active credit and case basis) was $255,825 and $220,074 at June 30, 2007 and December 31, 2006, respectively. Due to the relatively small number and large size of certain insured obligations comprising the active and case basis credit reserves, improvements or further deterioration in any one credit may significantly impact our loss provision in a given period. The provision for losses and loss expenses in the accompanying Consolidated Statements of Operations represents the expense recorded to bring the total reserve to a level determined by management to be adequate for losses inherent in the non-derivative financial guarantee insurance portfolio. Ambac’s management believes that the reserves for losses and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.

Our liabilities for credit losses are based in part on the short-duration accounting guidance in SFAS 60, “Accounting and Reporting by Insurance Enterprises.” The trustee (on behalf of the insured party), named beneficiary or custodian has a right to a claim payment under the financial guarantee insurance policy at the date of the first scheduled debt service payment of a defaulted security in the amount equal to the payment shortfall. We believe a loss event occurs for financial guarantee insurance products at the time the issuers’ financial condition deteriorates to an impaired credit status rather than at the time the insured party has a right to a claim payment. Because of this belief and the ambiguities discussed below in the application of SFAS 60 to the financial guarantee industry, Ambac does not believe that SFAS 60 alone provides sufficient guidance. As a result, Ambac supplements the guidance in SFAS 60 with the guidance in SFAS 5, “Accounting for Contingencies,” which calls for a loss to be accrued if it is probable that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. Ambac also relies by analogy on EITF Issue 85-20, “Recognition of Fees for Guaranteeing a Loan,” which states that a guarantor should perform an ongoing assessment of the probability of loss to determine if a liability (and a loss) should be recognized under SFAS 5.

In management’s view, the accounting guidance noted above does not comprehensively address the attributes of financial guarantee insurance contracts, primarily due to the fact that SFAS 60 was developed prior to the maturity of the financial guarantee industry. Financial guarantee contracts have elements of long-duration insurance contracts in that they are generally irrevocable and extend over a period of time that may be 30 years or more but are considered and reported for regulatory purposes as property and casualty insurance, normally considered short-duration contracts. The short-duration and long-duration classifications have different methods of accounting for premium revenue, deferred acquisition costs and contract liability recognition.

Ambac is aware that there are certain differences regarding the measurement of liabilities for credit losses among participants in the financial guarantee industry. Difficulties in applying the existing insurance accounting literature; such as the classification of the insurance contracts as either short-duration or long-duration to the attributes of financial guarantee insurance, different

10

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

measurement models and assumptions utilized, regulatory guidance provided to certain entities, and the existence of accounting literature providing guidance with respect to liability recognition for loan guarantees are the reasons for differences among the industry participants.

In January and February of 2005, the Securities and Exchange Commission staff discussed with the financial guarantee industry participants differences in loss reserve recognition practices among those participants. In June 2005, the Financial Accounting Standards Board (“FASB”) added a project to its agenda to consider the accounting by financial guarantee insurers for claims liability recognition, premium recognition and deferred acquisition costs. The proposed guidance was issued on April 18, 2007 and the final guidance is expected to be issued in the first quarter of 2008.

(4) Derivative Contracts

SFAS 133 “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS 138, SFAS 149 and SFAS 155, establishes accounting and reporting standards for derivative instruments. All derivatives, whether designed for hedging relationships or not, are required to be recorded on the Consolidated Balance Sheets at fair value. When available, quotes are obtained from independent market sources. However, when quotes are not available, Ambac uses internally developed valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. The valuation results from these models could differ materially from amounts that would actually be realized in the market. In accordance with the Emerging Issues Task Force (EITF) Issue 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (EITF 02-3), recognition of a trading profit or loss at inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating observable market data. Ambac defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. The deferral is recognized in income when the market data becomes observable or over the life of the transaction. The fair value includes an adjustment for counterparty credit risk and other adjustments, as appropriate, to reflect liquidity and ongoing servicing costs.

All derivative contracts are recorded on the Consolidated Balance Sheets on a gross basis; assets and liabilities are netted by customer only when a legal right of set-off exists. Gross asset and gross liability balances for all derivatives are recorded as Derivative Assets or Derivative Liabilities on the Consolidated Balance Sheets.

Derivative Contracts Classified as Held for Trading Purposes:

Financial Guarantee Credit Derivatives:

Ambac Assurance Corporation, through its subsidiary Ambac Credit Products, enters into credit derivative transactions with various financial institutions. Management views these credit derivative transactions as an extension of its financial guarantee business, under which Ambac intends to hold its position for the entire term of the related contract. These credit derivative contracts are accounted for at fair value since they do not qualify for the financial guarantee scope

11

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

exception under SFAS 133, as amended. Changes in fair value are recorded in the Consolidated Statement of Operations. The fee component is reflected in “Other Credit Enhancement Fees”, and the mark-to-market gains or losses associated with fair value changes are reflected in “Net Mark-to-Market (Losses) Gains on Credit Derivative Contracts”.

Financial Services Derivative Products:

Ambac, through its subsidiary Ambac Financial Services, provides interest rate and currency swaps to states, municipalities and their authorities, asset-backed issuers and other entities in connection with their financings. Ambac Capital Services enters into total return swaps with professional counterparties. Total return swaps are primarily referenced to fixed income obligations, which meet Ambac Assurance’s financial guarantee credit underwriting criteria. These contracts are recorded on trade date at fair value. Changes in fair value are recorded in the Consolidated Statements of Operations. The entire change in fair value of interest rate and currency swaps and the fee component of total returns swaps are reflected in “Derivative Product Revenues” and the mark-to-market gains or losses associated with the fair value changes on total return swaps are reflected in “Net Mark-to-Market (Losses) Gains on Total Return Swap Contracts”.

Derivative Contracts used for Non-Trading and Hedging Purposes:

In order to qualify for hedge accounting, a derivative must be considered highly effective at reducing the risk associated with the exposure being hedged. Each derivative must be designated as a hedge, with documentation of the risk management objective and strategy, including identification of the hedging instrument, the hedged item, the risk exposure, and how effectiveness will be assessed prospectively and retrospectively. The extent to which a hedging instrument is effective at achieving offsetting changes in fair values or cash flows must be assessed at least quarterly. Any ineffectiveness must be reported in net income.

Interest rate and currency swaps are utilized to hedge exposure to changes in fair value of assets or liabilities resulting from changes in interest rates and foreign exchange rates, respectively. These interest rate and currency swap hedges are referred to as “fair value” hedges. If the provisions of the derivative contract meet the technical requirements for fair value hedge accounting under SFAS 133, the change in fair value (gain or loss) of the derivative contract, excluding accrued interest, is recorded as “Net mark-to-market gains (losses) on non-trading derivatives”. Changes in the accrued interest component of the derivative contract are recorded as “Investment income” as an offset to changes in the accrued interest component on the hedged asset or liability. The change in fair value (gain or loss) of the related hedged asset or liability attributable to the hedged risk (interest rate or foreign exchange risk) adjusts the carrying amount of the hedged item and is recorded as a component of “Net mark-to-market gains (losses) on non-trading derivatives”. The net amount recorded in “Net mark-to-market gains (losses) on non-trading derivatives” related to derivative hedges and hedged assets and liabilities represents hedge ineffectiveness, and was $314 and ($125) for the three months ended June 30, 2007 and 2006, respectively and ($196) and $168 for the six months ended June 30, 2007 and 2006, respectively.

Interest rate swaps are also utilized to hedge the exposure to changes in cash flows caused by variable interest rates. These interest rate swap hedges are referred to as “cash flow” hedges. The effective portion of the gains and losses on interest rate swaps that meet the technical requirements for cash flow hedge accounting under SFAS 133 are reported in “Accumulated Other Comprehensive Income” in Stockholders’ Equity. Amounts reported in

12

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

“Accumulated Other Comprehensive Income” are reclassified into “Interest income” in the same period which earnings are affected by the designated hedged asset or liability. If the cumulative portion of the gains and losses on cash flow hedges exceeds the cumulative portion of gains and losses on the hedged assets or liabilities, that excess is considered hedge ineffectiveness and reported as a component of “Net mark-to-market gains (losses) on non-trading derivatives”. For the three months ended June 30, 2007 and 2006, $135 and $118, respectively, and $286 and $372 for the six months ended June 30, 2007 and 2006, respectively, of cash flow hedge ineffectiveness was reported in net income. As of June 30, 2007, $591 of pre-tax deferred losses on derivative instruments reported in Accumulated Other Comprehensive Income are expected to be reclassified to net income during the next twelve months. Transactions and events expected to occur over the next twelve months that will necessitate reclassifying these derivative losses include the repricing of variable-rate medium-term notes (“MTNs”).

Ambac enters into non-trading derivative contracts for the purpose of economically hedging exposures to fair value or cash flow changes caused by fluctuations in interest rates and foreign currency rates. If the hedging relationship does not meet the technical requirements for hedge accounting under SFAS 133, changes to the fair value of the derivative contract are recorded as a component of “Net mark-to-market (losses) gains on non-trading derivative contracts” in the accompanying Consolidated Statements of Operations. The change in fair value of such derivative contracts for the three months ended June 30, 2007 and 2006 was $26 and ($181), respectively, and $37 and ($230) for the six months ended June 30, 2007 and 2006, respectively.

Ambac discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative expires, is sold or terminated. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, Ambac continues to carry the derivative on the balance sheet at its fair value, and no longer adjusts the hedged asset or liability for changes in fair value. The adjustment of the carrying amount of the hedged asset or liability is accounted for in the same manner as other components of the carrying amount of that asset or liability. The net derivative gain or loss related to a discontinued cash flow hedge (recognized during the period of hedge effectiveness) will continue to be reported in Accumulated Other Comprehensive Income and amortized into net income as a yield adjustment to the previously designated asset or liability. If the previously designated asset or liability is sold or matures, the net derivative gain or loss related to a discontinued cash flow hedge reported in Accumulated Other Comprehensive Income will be reclassified into net income immediately. All subsequent changes in fair values of derivatives previously designated as cash flow hedges will be recognized in net income.

(5) Income Taxes

On January 1, 2007, Ambac adopted the provisions of FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes”, an interpretation of SFAS 109, which provides a framework to determine the appropriate level of tax reserves for uncertain tax positions. FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition. Ambac’s liability for unrecognized tax benefits was not impacted as a result of the adoption of FIN 48.

13

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

Ambac files a consolidated Federal income tax return with its subsidiaries. Ambac and its subsidiaries also file separate or combined income tax returns in various states, local and foreign jurisdictions.

The following are the major jurisdictions in which Ambac and its affiliates operate and the earliest tax years subject to examination:

Jurisdiction	Tax Year
United States	2001
New York State	2005
New York City	2000
United Kingdom	2005

As of June 30, 2007 and December 31, 2006, the liability for unrecognized tax benefits is approximately $66,010 and $59,600, respectively. Included in these balances at June 30, 2007 and December 31, 2006 are $42,210 and $35,800, respectively, of unrecognized tax benefits that, if recognized, would affect the effective tax rate. Over the next 12 months, Ambac estimates it may decrease federal tax reserves related to the unrecognized tax benefits by approximately $11,200 for issues that may no longer warrant a tax reserve after an expected settlement for the years 2001 through 2004.

Ambac accrues interest and penalties related to unrecognized tax benefits in the provision for income taxes. During the three months ended June 30, 2007 and 2006, Ambac recognized approximately $780 and $400, respectively, in interest. Ambac had approximately $3,610 and $2,200 for the payment of interest accrued at June 30, 2007 and December 31, 2006, respectively.

(6) Special Purpose Entities and Variable Interest Entities

Ambac has involvement with special purpose entities, including VIEs in the following ways. First, Ambac is a provider of financial guarantee insurance for various debt obligations. Second, Ambac has sponsored two special purpose entities that issue MTNs to fund the purchase of certain financial assets. As discussed in detail below, these Ambac-sponsored special purpose entities are considered Qualifying Special Purpose Entities (“QSPEs”). Lastly, Ambac is an investor in asset-backed securities issued by VIEs, and, in one transaction, has a beneficial interest in a VIE that purchases fixed rate municipal bonds with proceeds from the issuance of floating rate short term beneficial interests as discussed in detail below.

Financial Guarantees:

Ambac provides financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs. Ambac’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structure provides certain financial protection to Ambac. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread. In the case of over-collateralization, (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by Ambac Assurance), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the structured finance obligations that have been guaranteed by Ambac. In the

14

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

case of first loss, the financial guarantee insurance policy only covers a senior layer of losses on assets held or debt issued by special purpose entities, including VIEs. The first loss with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate interest cash flows that are in excess of the interest payments on the related debt; such excess cash flow is applied to redeem debt, thus creating over-collateralization.

As of June 30, 2007, Ambac is the primary beneficiary and therefore consolidated a VIE under one transaction as a result of providing a financial guaranty. The VIE is a bankruptcy remote special purpose financing entity created by the issuer of debt securities to facilitate the sale of notes guaranteed by Ambac Assurance. Ambac is not primarily liable for the debt obligations of the VIE. Ambac would only be required to make payments on these debt obligations in the event that the issuer defaults on any principal or interest due. Additionally, Ambac’s creditors do not have rights with regard to the assets of the VIE.

Proceeds from the note issuance of the VIE, were used to extend loans to universities in the United Kingdom. The financial reports of this VIE are prepared by an outside trustee and are not available within the time constraints Ambac requires to ensure the financial accuracy of the operating results. As such, the financial results of the VIE will be consolidated on a one quarter lag. Total long-term debt outstanding under this note issuance was $275,490 with a maturity date of December 7, 2047 and a fixed rate of interest of 5.32% at June 30, 2007. Ambac is subject to potential consolidation of an additional $743,000 of assets and liabilities in connection with future utilization of the VIE.

The following table provides supplemental information about the combined assets and liabilities associated with the VIE discussed above. The assets and liabilities of the VIE are consolidated into the respective Balance Sheet captions.

	At June 30, 2007		At December 31, 2006
Assets:
Cash	$	9,027	$	—
Investment income due and accrued		359		—
Loans		261,047		—
Other assets		5,057		—
Total assets	$	275,490		—
Liabilities:
Long-term debt	$	275,490	$	—
Total liabilities		275,490		—
Stockholders’ equity:		—		—
Total liabilities and stockholders’ equity	$	275,490	$	—

15

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

Qualified Special Purpose Entities:

A subsidiary of Ambac has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). QSPEs are not subject to the requirements of FIN 46(R) and accordingly are not consolidated in Ambac’s financial statements. The QSPEs are legal entities that are demonstrably distinct from Ambac. Ambac, its affiliates or its agents cannot unilaterally dissolve the QSPEs. The QSPEs permitted activities are limited to those outlined below.

As of June 30, 2007, there have been 15 individual transactions processed through the QSPEs of which 10 are outstanding. In each case, a subsidiary of Ambac sold fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPEs and the absence of any agreement or obligation for Ambac to repurchase or redeem assets of the QSPEs. Additionally, Ambac’s creditors do not have any rights with regards to the assets of the QSPEs. The purchase by the QSPEs is financed through the issuance of MTNs, which are collateralized by the purchased assets. Derivative contracts (interest rate and currency swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchase, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued and/or the related derivative contracts. As of June 30, 2007, Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the QSPEs.

Pursuant to the terms of Ambac Assurance’s insurance policy, insurance premiums are paid to Ambac Assurance by the QSPEs and are earned in a manner consistent with other insurance policies, over the risk period. Any losses incurred would be included in Ambac’s Consolidated Statements of Operations. Under the terms of an Administrative Agency Agreement, Ambac provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.

Assets sold to the QSPEs during the six months ended June 30, 2007 and the year ended December 31, 2006 were $0 and $450,000, respectively. No gains or losses were recognized on the sales in either period. As of June 30, 2007, the estimated fair value of financial assets, MTN liabilities and derivative hedge assets of the QSPEs was $1,941,079, $2,005,069 and $39,008, respectively. When market quotes are not available, fair values are based on internal valuation models, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $3,173 and $2,572 for the six months ended June 30, 2007 and 2006, respectively. Ambac also received fees for providing other services amounting to $126 and $140 for the six months ended June 30, 2007 and 2006, respectively.

16

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

VIE Beneficial Interest:

Ambac owns a beneficial interest in a special purpose entity that meets the definition of a VIE. This entity has issued floating rate beneficial interests to investors and invested the proceeds in fixed rate municipal debt securities. These beneficial interests are directly secured by the related municipal debt securities. Ambac is the primary beneficiary of this entity as a result of its beneficial interest. The fixed rate municipal debt securities, which are reported as “Investments in fixed income securities, at fair value” on the Consolidated Balance Sheets, were $254,187 and $258,976 as of June 30, 2007 and December 31, 2006, respectively. The beneficial interests issued to third parties, reported as “Obligations under investment and payment agreements” on the Consolidated Balance Sheets, were $248,225 and $248,415 as of June 30, 2007 and December 31, 2006, respectively. Under the terms of these beneficial interests, the investors have the contractual right to redeem their investment at any time, with five business days notice. As of June 30, 2007 and December 31, 2006, the interest rates on these beneficial interests ranged from 3.62% to 3.99% and from 2.95% to 4.01%, respectively.

(7) Stockholders’ Equity

Ambac is authorized to issue 350,000,000 shares of Common Stock, par value $0.01 per share, of which 109,193,096 were issued and 101,733,454 were outstanding as of June 30, 2007. Ambac is also authorized to issue 4,000,000 shares of Preferred Stock, $0.01 par value per share, none of which was issued and outstanding as of June 30, 2007.

In 2007, Ambac’s shares held in treasury increased due to an accelerated share repurchase program, whereby Ambac repurchased 4,459,223 shares of common stock, and other share repurchases.

(8) Segment Information

Ambac has two reportable segments, as follows: (1) Financial Guarantee, which provides financial guarantees (including credit derivatives) for public and structured finance obligations; and (2) Financial Services, which provides investment agreements, funding conduits, interest rate, total return and currency swaps, principally to clients of the financial guarantee business. Ambac’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different marketing strategies, personnel skill sets and technology.

Ambac Assurance guarantees the swap and investment agreement obligations of its Financial Services affiliates. Intersegment revenues include the premiums earned under those agreements and dividends received from its Financial Services subsidiaries. Such premiums are determined as if they were premiums paid by third parties, that is, at current market prices.

Information provided below for “Corporate and Other” relates to Ambac corporate activities, including interest expense on debentures. Corporate and other revenue from unaffiliated customers consists primarily of interest income. Intersegment revenues consist of dividends received.

17

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

The following tables are a summary of financial information by reportable segment as of and for the three and six month periods ended June 30, 2007 and 2006:

(Dollars in thousands) Three months ended June 30,	Financial Guarantee		Financial Services			Corporate and Other			Intersegment Eliminations			Consolidated
2007:
Revenues:
Unaffiliated customers	$	301,204	$	110,035		$	1,341		$	—		$	412,580
Intersegment		5,005		(4,698	)		51,584			(51,891	)		—
Total revenues	$	306,209	$	105,337		$	52,925		$	(51,891	)	$	412,580
Income before income taxes:
Unaffiliated customers	$	250,670	$	5,794		$	(24,414	)	$	—		$	232,050
Intersegment		7,734		(7,213	)		50,222			(50,743	)		—
Total income before income taxes	$	258,404	$	(1,419	)	$	25,808		$	(50,743	)	$	232,050
Total assets	$	11,219,158	$	9,727,447		$	115,136		$	—		$	21,061,741
2006:
Revenues:
Unaffiliated customers	$	340,165	$	144,609		$	4,187		$	—		$	488,961
Intersegment		1,119		(1,057	)		58,525			(58,587	)		—
Total revenues	$	341,284	$	143,552		$	62,712		$	(58,587	)	$	488,961
Income before income taxes:
Unaffiliated customers	$	295,478	$	50,773		$	(19,288	)	$	—		$	326,963
Intersegment		5,064		(1,941	)		57,530			(60,653	)		—
Total income before income taxes	$	300,542	$	48,832		$	38,242		$	(60,653	)	$	326,963
Total assets	$	10,085,933	$	8,962,387		$	243,795		$	—		$	19,292,115

(Dollars in thousands) Six months ended June 30,	Financial Guarantee		Financial Services			Corporate And Other			Intersegment Eliminations			Consolidated
2007:
Revenues:
Unaffiliated customers	$	642,999	$	228,488		$	2,922		$	—		$	874,409
Intersegment		7,976		(7,379	)		101,761			(102,358	)		—
Total revenues	$	650,975	$	221,109		$	104,683		$	(102,358	)	$	874,409
Income before income taxes:
Unaffiliated customers	$	544,667	$	22,001		$	(45,378	)	$	—		$	521,290
Intersegment		13,434		(10,969	)		99,262			(101,727	)		—
Total income before income taxes	$	558,101	$	11,032		$	53,884		$	(101,727	)	$	521,290
Total assets	$	11,219,158	$	9,727,447		$	115,136		$	—		$	21,061,741
2006:
Revenues:
Unaffiliated customers	$	680,855	$	242,200		$	7,187		$	—		$	930,242
Intersegment		13,228		(2,115	)		92,525			(103,638	)		—
Total revenues	$	694,083	$	240,085		$	99,712		$	(103,638	)	$	930,242
Income before income taxes:
Unaffiliated customers	$	598,183	$	69,827		$	(39,406	)	$	—		$	628,604
Intersegment		18,557		(3,888	)		90,535			(105,204	)		—
Total income before income taxes	$	616,740	$	65,939		$	51,129		$	(105,204	)	$	628,604
Total assets	$	10,085,933	$	8,962,387		$	243,795		$	—		$	19,292,115

18

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

The following table summarizes gross premiums written and net premiums earned and other credit enhancement fees included in the Financial Guarantee segment by location of risk for the three and six months ended June 30, 2007 and 2006:

(Dollars in thousands)	Three Months				Six Months
	Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees		Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees
2007:
United States	$	199,266	$	180,683	$	396,892	$	355,551
United Kingdom		27,571		18,455		45,042		37,017
Other International		34,302		39,213		69,117		77,342
Total	$	261,139	$	238,351	$	511,051	$	469,910
2006:
United States	$	213,113	$	169,887	$	384,203	$	326,482
United Kingdom		57,440		16,735		73,586		32,105
Other International		42,947		38,362		74,769		74,817
Total	$	313,500	$	224,984	$	532,558	$	433,404

(9) Future Application of Accounting Standards

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In addition, SFAS 157 supersedes certain accounting guidance, which prohibited the recognition of day one gains on certain derivative transactions. With the adoption of SFAS 157, any remaining reserves for day one gains will be reflected as a cumulative effect adjustment to the opening balance of retained earnings. Ambac is currently evaluating the implications of SFAS 157 on its financial statements.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS 159 permits reporting entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments and not to portions of instruments. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years that begin after November 15, 2007. Ambac is currently evaluating the implications of SFAS 159 on its financial statements.

On April 18, 2007, the FASB issued an Exposure Draft (“ED”) for a proposed SFAS “Accounting for Financial Guarantee Insurance Contracts”, an interpretation of SFAS 60, “Accounting and Reporting by Insurance Enterprises”. The ED clarifies how SFAS 60 applies to financial guarantee insurance contracts issued by insurance enterprises, including the methodology to account for premium revenue and claim liabilities. The comment period for the ED ended on June 18, 2007 and the final Statement is expected to be issued in the first quarter of 2008. The final Statement shall be applied to existing and future financial guarantee

19

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

insurance contracts. The cumulative effect of initially applying this final Statement will be recorded as an adjustment to the opening balance of retained earnings for that fiscal year. For additional disclosure regarding the ED, see “Financial Guarantee Exposure Draft” located in Management’s Discussion and Analysis.

In April 2007, the FASB issued FASB Staff Position (“FSP”) FIN 39-1, an amendment of FASB Interpretation No. 39. FSP FIN 39-1 permits fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a liability) to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under the same master netting arrangement. The decision to offset fair value amounts constitutes an accounting policy election by the entity. A reporting entity shall not offset fair value amounts recognized for derivative instruments without offsetting fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007, with earlier application permitted. An entity must recognize the effect of applying FSP FIN 39-1 retrospectively as a change in accounting principle for all financial statement periods presented, unless it is impracticable to do so. Ambac is currently evaluating the implications of FSP FIN 39-1 on its financial statements.

20

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995

In this discussion, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These statements may relate to our future plans and objectives, among other things. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K and “Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995” in Part I, Item 1 of the Annual Report on Form 10-K.

Any or all of management’s forward-looking statements here or in other publications may turn out to be wrong and are based on current expectations and the current economic environment. Ambac’s actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among factors that could cause actual results to differ materially are: (1) changes in the economic, credit, foreign currency or interest rate environment in the United States and abroad; (2) the level of activity within the national and worldwide credit markets; (3) competitive conditions and pricing levels; (4) legislative and regulatory developments; (5) changes in tax laws; (6) the policies and actions of the United States and other governments; (7) changes in capital requirements whether resulting from large numbers of downgrades in our insured portfolio or changes in rating agencies’ rating criteria with respect to financial guaranty insurers; (8) changes in Ambac’s and/or Ambac Assurance’s credit or financial strength ratings; (9) changes in accounting principles or practices that may impact Ambac’s reported financial results; (10) inadequacy of reserves established for losses and loss expenses; (11) default of one or more of Ambac Assurance’s reinsurers; (12) market spreads and pricing on insured pooled debt obligations and other derivative products insured or issued by Ambac; (13) prepayment speeds on insured asset-backed securities and other factors that may influence the amount of installment premiums paid to Ambac Assurance; and (14) other risks and uncertainties that have not been identified at this time. Ambac is not obligated to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in Ambac’s reports to the SEC.

Introduction

Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose subsidiaries provide financial guarantee products and other financial services to clients in both the public and private sectors around the world.

Ambac’s principal operating subsidiary, Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch Inc. Financial guarantee insurance is a promise to pay scheduled interest and principal if the issuer fails to meet its obligations. A bond guaranteed by Ambac Assurance receives triple-A ratings, typically resulting in lower financing costs for the

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

issuer and generally makes the issue more marketable, both in the primary and secondary markets. As an alternative to financial guarantee insurance, credit protection relating to a particular pool of assets, security or issuer can be provided through a credit derivative.

Ambac’s activities are divided into two business segments: (i) Financial Guarantee and (ii) Financial Services.

Ambac reports its financial guarantee business segment broken out by three principal markets: Public Finance, Structured Finance and International Finance. Public Finance includes all U.S. municipal issuance including general obligations, lease and tax-backed obligations, health care, public utilities, transportation and higher education, as well as certain infrastructure privatization transactions, such as toll road and bridge financings, public transportation financings, stadium financings, military housing and student housing. Structured Finance obligations include securitizations of a variety of asset types such as mortgage loans, home equity loans, student loans, credit card receivables, operating assets, leases, pooled debt obligations, investor-owned utilities and asset-backed commercial paper conduits originated in the U.S. Included within the operating asset sector are securitizations including aircraft, rental car fleets, shipping containers, rail cars, film rights, franchise fees, pharmaceutical royalties, and intellectual property. International Finance covers public purpose infrastructure projects, utilities, and various types of structured financings originated outside of the U.S, including asset-backed securities, whole business and future flow securitizations. International structured financings also encompass pooled debt obligations that may include significant components of domestic exposures.

Management believes that the financial guarantee business thrives on economic cycles. For example, a strong economic environment with good or improving credit is beneficial to our financial guarantee portfolio. However, such conditions, if in place for an extended period of time, will reduce credit spreads and result in lower pricing. Conversely, in a deteriorating credit environment, credit spreads widen and pricing for our product improves. However, if the weakening environment is prolonged, the stresses on our portfolio could result in claims payments in excess of normal or historical expectations. Ambac’s management believes that its business is well positioned to withstand, and in fact prosper, within normal economic and business cycles. Further, Ambac’s financial guarantee business today enjoys a strong competitive position in a variety of product segments on a global scale and is positioned for further geographic product expansion. Management believes that geographic product expansion will be driven, over the long term, by critical infrastructure needs worldwide and the expansion of global credit markets.

Ambac’s Financial Services segment provides financial and investment products including investment agreements, interest rate swaps, currency swaps, and funding conduits, principally to clients of the financial guarantee business. Additionally, the Financial Services segment enters into total return swaps with professional counterparties. Ambac focuses on these businesses due to the complementary nature of the products to its financial guarantee product.

Overview

Ambac’s diluted earnings per share were $1.67 and $3.70 for the three and six months ended June 30, 2007, a 25% decrease from $2.22 per diluted share in the second quarter of 2006 and a 14% decrease from $4.28 per diluted share in the six months ended June 30, 2006. These negative variances were primarily driven by (i) unrealized mark-to-market losses on credit derivative exposures in the second quarter of 2007 resulting from unfavorable market pricing of

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

collateralized debt obligations with significant amounts of sub-prime residential mortgage collateral, and (ii) net realized gains on investment securities in the second quarter of 2006 resulting from cash recoveries received related to a security in the investment agreement portfolio, and (iii) higher loss and loss expenses in 2007. In addition, the six months ended June 30, 2007 earnings were impacted by a large gain in 2006 from the sale of three aircraft related to a previously reported defaulted enhanced equipment trust certificate (reported as “Other Income” in the accompanying Consolidated Statements of Operations). Return on average shareholders’ equity was 11.5% and 12.6% for the three and six months ended June 30, 2007, respectively, compared to 17.2% and 16.7% for the three and six months ended June 30, 2006, respectively.

During the second quarter of 2007, Ambac completed the buyback of $400 million of its common stock under its accelerated share buyback program. The total number of shares purchased under the agreement amounted to 4.46 million common shares.

Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting estimates are defined as those that require management to make significant judgments and could potentially result in materially different results under different assumptions and conditions. Management has identified the accounting for loss and loss expenses and the valuation of financial instruments as critical accounting estimates. This discussion should be read in conjunction with the consolidated financial statements and notes thereon included elsewhere in this report, and in the 2006 Form 10-K filed with the SEC on March 1, 2007.

Financial Guarantee Insurance Losses and Loss Expenses. The loss reserve for financial guarantee insurance discussed in this critical accounting estimates disclosure relates only to Ambac’s non-derivative insurance business. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative Financial Guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments.

The liability for losses and loss expenses consists of active credit and case basis credit reserves. Ambac establishes an active credit reserve to reflect probable and estimable losses due to credit deterioration on insured credits that have not yet defaulted or been reported as of the reporting date. The active credit reserve is established through a process that begins with estimates of probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac’s internal system of credit ratings, which are analogous to the risk ratings of the major rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) the net par outstanding on the adversely classified credit. The loss severities and default information are based on rating agency information and are

23

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

specific to each bond type and are established and approved by Ambac’s Portfolio Risk Management Committee. The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac. Our Surveillance group is responsible for designating the classified rating of individual credits and assigning credit ratings, which in turn affect default probabilities used in estimating active credit reserves.

For certain adversely classified credit exposures, Ambac’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities applied to adversely classified credits can include various actions by Ambac. The most common actions include obtaining detailed appraisal information on collateral, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical approach discussed above.

Case basis credit reserves are established for losses on insured obligations that have already defaulted. We believe our definition of case basis credit reserves differs from other financial guarantee industry participants. Our case reserves represent the present value of anticipated loss and loss expense payments expected over the estimated period of default. Loss and loss expenses consider defaulted debt service payments, estimated expenses associated with settling the claims and estimated recoveries under collateral and subrogation rights.

The primary assumptions impacting the estimate of loss reserves are the probability of default and severity of loss given a default. The probability of default assumption represents the percentage chance that a particular insured obligation will default over its remaining life. Probability of default assumptions are based upon rating agency studies of bond defaults given a particular asset class, rating and remaining tenor of an underlying obligation, modified as appropriate by Ambac’s experience and judgment. Severity of loss represents the amount of loss that would be incurred on a defaulted obligation due to the difference in the amount of net par guaranteed and the value of the related collateral and other subrogation rights. Loss severity estimates are based upon available evidence such as rating agency recovery rates with respect to debt obligations in the particular asset class, review of financial statements, collateral performance, and/or surveillance data such as collateral appraisals. However, when credits are in default or have specific attributes that warrant an adjustment, we typically develop a best estimate of the loss based upon transaction specific elements rather than a statistical loss as our knowledge is greater as to the ultimate outcome of these credits due to our surveillance and remediation activity.

For the active credit reserve component of our total reserves, as the probability of default for an individual credit increases and/or the severity of loss given a default increases, our loss reserve for that insured obligation will also increase. Political, economic or other unforeseen events could have an adverse impact on default probabilities and loss severities. Our experience has shown that credit deterioration and related changes in the default probabilities are generally gradual processes that typically occur over a long period of time. Nonetheless, downgrades to the underlying rating of a classified credit, particularly those individual credits with a large net par balance, could have a significant impact on our reserves. Case basis credit reserves are only sensitive to severity assumptions because the underlying financial obligation has already defaulted (that is, a 100% probability of default).

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Adjustments to our loss reserves may create volatility in our financial results in any given quarter or year. Loss reserve volatility will be a direct result of the credit performance of our insured portfolio including the number, size, asset classes and quality of credits included on our classified list. The number and severity of adversely classified credits depend to a large extent on transaction specific attributes, but will generally increase during periods of economic stress and decline during periods of economic stability. Due to the small number of credits and size of certain individual adversely classified credits, modest changes in underlying ratings or classifications can have a large impact on any quarter’s provision for losses and loss expenses. Furthermore, external influences on our transactions beyond our control may result in favorable or unfavorable development on our reserves. Historically Ambac has not ceded large percentages of outstanding exposures to our reinsurers, therefore, reinsurance recoveries have not had a significant effect on loss reserve volatility. The table below indicates the number of credits and net par outstanding for case and active credit reserves at June 30, 2007:

	Number of credits	Net par outstanding
Active credit reserves	46	$	3,224 million
Case reserves	7		495 million
Totals	53	$	3,719 million

Ambac has exposure to various bond types issued in the debt capital markets. Our experience has shown that for the majority of bond types, we have not experienced claims and therefore the estimate of loss severity has remained constant. However, for certain bond types, Ambac has loss experience that indicates that factors or events could have a material impact on the original estimate of loss severity. We have observed that, with respect to four bond types in particular, it is reasonably possible that a material change in actual loss severities could occur over time. These four bond types are healthcare institutions, aircraft lease securitizations known as Enhanced Equipment Trust Certificates (“EETC”), collateralized debt obligations (“CDOs”) and mortgage-backed and home equity securitizations. These four bond kinds represent 52% of our ever-to-date claim payments. Typically, bonds insured by Ambac in the healthcare sector are secured by revenues generated by a hospital enterprise. The value of a hospital and its ability to generate revenues are primarily impacted by the essentiality of that hospital enterprise to a particular community. For example, hospitals that do not have significant competition in a community generally have more stable collateral values than facilities in communities with significant competition. Intense competition in the global airline industry and high energy costs could adversely impact our EETC transactions. We currently do not have any exposure to EETC in our classified credit portfolio. Increases in residential mortgage defaults as a result of fraud, unemployment and/or personal bankruptcies could adversely impact residential real estate values and the probability of default and severity of loss for our transactions. As a result of our experience to date, we note that the mortgage-backed and home equity ultimate severities have been less than or equal to our current severity assumption. However, our past experience had been observed during a period of rising real estate values for much of the United States. When calculating modeled loss estimates for an insured CDO obligation, Ambac considers the unique attributes of the underlying collateral and transaction. It is reasonably possible that loss estimates for CDOs may increase as a result of increased probability of default and severity of loss of the underlying collateral; however Ambac’s exposure to CDOs in its classified credit portfolio is currently limited.

Currently, the credits that comprise our case basis credit reserves only include mortgage-backed and home equities from the four bond kinds discussed above. The case basis credit reserve for mortgage-backed and home equity transactions, was approximately $5.2 million at June 30, 2007.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Generally, severity assumptions are established within our ACR for entire asset classes and therefore represent an average severity of loss given a default. However, it is our experience that ultimate severity outcomes often vary from averages. Therefore, we have not provided reasonably possible negative scenarios for the severity assumption. The table below outlines the estimated impact on the June 30, 2007 consolidated loss reserve from reasonably possible increases in the probability of default estimate arising via an assumption of one full letter downgrade for each credit of the appropriate bond type that presently resides within the adversely classified credit listing.

(Dollars in millions) Category	Net Par Outstanding		Increase in Reserve Estimate
Transportation	$	1,069	$	134
Mortgage-backed and home equity	$	1,319	$	53
Health care	$	472	$	39

Ambac’s management believes that the reserves for losses and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.

Valuation of Financial Instruments. The fair market values of financial instruments held are determined by using independent market quotes when available and valuation models when market quotes are not available. Ambac’s financial instruments categorized as assets are mainly comprised of investments in fixed income securities and derivative contracts.

Investments in fixed income securities are accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) 115, “Accounting for Certain Investments in Debt and Equity Securities”. SFAS 115 requires that all debt instruments and certain equity instruments be classified in Ambac’s balance sheet according to their purpose and, depending on that classification, be carried at either cost or fair market value. The fair values of fixed income investments are based primarily on quoted market prices received from a nationally recognized pricing service or dealer quotes. For those fixed income investments where quotes were not available, fair values are based on internal valuation models. Key inputs to the internal valuation models include maturity date, coupon and generic yield curves for industry and credit rating characteristics that closely match those characteristics of the specific investment securities being valued. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Approximately 1% of the investment portfolio was valued using internal valuation models at June 30, 2007 and December 31, 2006.

Ambac’s exposure to derivative instruments is created through interest rate, currency, total return and credit default swaps. These contracts are accounted for at fair value under SFAS 133 “Accounting for Derivative Instruments and Certain Hedging Activities,” as amended (“SFAS 133”). Fair value is determined based upon market quotes from independent sources, when available. When independent quotes are not available, fair value is determined using valuation models. These valuation models require market-driven inputs, including contractual

26

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. Due to the size of credits in our credit derivative portfolio, modest changes in factors that impact their fair value can have a large impact on any quarter’s mark-to-market gains or losses. Fair value of credit derivative contracts are primarily driven by the fair value of their underlying reference obligation and the primary drivers to changes to such fair values are credit and liquidity. So far in the third quarter of 2007, we have observed a continued lack of liquidity in the collateralized debt obligation market and as a result future mark-to-market losses may be greater than our historical experience. The net fair value of derivative contracts at June 30, 2007 and December 31, 2006 was $264 million and $352 million, respectively. This decrease in net asset value relates primarily to the unrealized mark-to-market loss on credit derivatives during the first half of 2007, along with a lower net fair value of derivative hedges caused by rising interest rates. Ambac uses both vendor-developed and proprietary models, based on the complexity of transactions. The selection of a model to value a derivative depends on the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. For derivatives that are less complex and trade in liquid markets, such as interest rate and currency swaps, we utilize vendor-developed models. For derivatives that trade in less liquid markets, such as credit derivatives on collateralized debt obligations and total return swaps, a proprietary model is used because such instruments tend to be more complex and pricing information is not readily available in the market. These models and the related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based on improvements in modeling techniques.

In accordance with the Emerging Issues Task Force (“EITF”) Issue 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (“EITF 02-3”), recognition of a trading profit or loss at inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating observable market data. Ambac defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. Management’s judgment is applied in recording adjustments to fair value that take into account various factors, including but not limited to, credit risk, future administration costs, the bid offer spread and illiquidity due to lack of market depth. The FASB issued SFAS 157, “Fair Value Measurements” in September 2006 which is effective for financial statements issued for fiscal years beginning after November 15, 2007 and will supersede the guidance in EITF 02-3. Please refer to Note 9 of the Consolidated Financial Statements for further discussion on how SFAS 157 will impact derivative transaction gains and losses.

Results of Operations

The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for the three and six months ended June 30, 2007 and 2006, and its financial condition as of June 30, 2007 and December 31, 2006.

Consolidated Net Income

Ambac’s net income for the three months ended June 30, 2007 was $173.0 million or $1.67 per diluted share, a decrease of $65.6 million or $0.55 per diluted share, compared to

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

$238.6 million, or $2.22 per diluted share in the three months ended June 30, 2006. Ambac’s income before income taxes was $232.1 million for the three months ended June 30, 2007, a decrease of 29% from income before income taxes of $327.0 million in the three months ended June 30, 2006. Of the $232.1 million of income before income taxes in the second quarter of 2007, $250.7 million was from Financial Guarantee, $5.8 million from Financial Services and $(24.4) million from Corporate, compared to $295.5 million, $50.8 million and $(19.3) million for Financial Guarantee, Financial Services and Corporate, respectively, in the second quarter of 2006. Corporate consists primarily of Ambac’s interest expense on its long-term debentures outstanding, partially offset by interest income on investments held at the parent company.

Financial Guarantee net income for the three months ended June 30, 2007 decreased primarily as a result of unrealized mark-to-market losses on credit derivative exposures driven primarily by the impact of market pricing of pooled debt obligations with significant amounts of sub-prime residential mortgage collateral, a higher provision for loss and loss expenses and higher underwriting and operating expenses, partially offset by higher net premiums earned, higher other income and higher net investment income. The Financial Services segment decrease in the second quarter of 2007 is primarily attributable to lower net realized gains, primarily from recoveries received from National Century Financial Enterprises, Inc. (“NCFE”) in the second quarter of 2006, lower derivative product revenue, and net mark-to-market losses on total return swaps.

Ambac’s net income for the six months ended June 30, 2007 was $386.4 million or $3.70 per diluted share, a decrease of $73.3 million compared to $459.7 million, or $4.28 per diluted share in the six months ended June 30, 2006. Ambac’s income before income taxes was $521.3 million for the six months ended June 30, 2007, a decrease of 17% from income before income taxes of $628.6 million in the six months ended June 30, 2006. Of the $521.3 million of income before income taxes in the six months ended June 30, 2007, $544.7 million was from Financial Guarantee, $22.0 million from Financial Services and $(45.4) million from Corporate, compared to $598.2 million, $69.8 million and $(39.4) million for Financial Guarantee, Financial Services and Corporate, respectively, in the six months ended June 30, 2006. Corporate consists primarily of Ambac’s interest expense on its long-term debentures outstanding, partially offset by interest income on investments held at the parent company.

Financial Guarantee net income for the six months ended June 30, 2007 decreased primarily as a result of the unrealized mark-to-market losses on credit derivative exposures mentioned above, lower other income from the 2006 sale of three aircraft from a defaulted enhanced equipment trust certificate transaction, and a higher provision for loss and loss expenses, partially offset by higher net premiums earned and higher net investment income. The Financial Services segment decrease in the six months of 2007 is primarily attributable to lower net realized gains as mentioned above, lower derivative product revenue, and lower net mark-to-market gains on total return swaps.

Included in the six months ended June 30, 2006 income before income taxes in the Financial Guarantee segment, is the impact from cancellations of the remaining reinsurance contracts with AXA Re Finance S.A. (“AXA Re”) and American Re-Insurance Company (“American Re”). The insured par that was recaptured as a result of the cancellation totaled approximately $3.9 billion. Included in ceded premiums written in Ambac’s Consolidated Statement of Operations is $37.0 million in returned premiums from the cancellation, of which $29.3 million was deferred. The difference, $7.7 million, included in net earned premiums, results from the difference between the negotiated amount of returned premiums and the

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

associated unearned premium remaining on the previously ceded portion of the underlying guarantees. The net impact of this cancellation to the Consolidated Statement of Operations amounted to approximately $3.1 million, $2.0 million after-tax.

Financial Guarantee Segment

Ambac provides financial guarantees in respect of debt obligations through its principal operating subsidiary, Ambac Assurance Corporation, as well as credit protection in the form of structured credit derivatives through Ambac Credit Products LLC, a wholly owned subsidiary of Ambac Assurance. Ambac provides these services in three principal markets: public finance, structured finance and international finance.

Ambac Assurance guaranteed $39.0 billion of gross par value bonds during the three months ended June 30, 2007, a decrease of 6% from $41.3 billion during the comparable prior year period. During the six months ended June 30, 2007, Ambac Assurance guaranteed $70.5 billion in par value debt obligations, a 1% increase from $69.8 billion in par value debt obligations guaranteed in the first six months of 2006.

The following table provides a breakdown of guaranteed net par outstanding by market sector at June 30, 2007 and December 31, 2006:

(Dollars in billions)	June 30, 2007		December 31, 2006
Public Finance	$	293.5	$	282.2
Structured Finance		176.9		162.6
International Finance		76.4		74.2
Total net par outstanding	$	546.8	$	519.0

The following tables provide a rating distribution of guaranteed net par outstanding based upon internal Ambac Assurance credit ratings at June 30, 2007 and December 31, 2006 and a distribution by bond type of Ambac Assurance’s below investment grade exposures at June 30, 2007 and December 31, 2006. Below investment grade is defined as those exposures with a credit rating below BBB-:

	Percentage of Guaranteed Portfolio(1)
	June 30, 2007		December 31, 2006
AAA	18	%	16	%
AA	20		20
A	41		43
BBB	20		20
Below investment grade	<1		1
Total	100	%	100	%

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Summary of Below Investment Grade Exposure ⁽¹⁾

Bond Type	June 30, 2007		December 31, 2006
(Dollars in millions)
Public Finance:
Transportation	$	1,232	$	1,264
Health care		436		404
General obligation		291		292
Tax-backed		134		134
University		30		69
Other		120		120
Total Public Finance		2,243		2,283
Structured Finance:
Mortgage-backed and home equity		1,140		848
Enhanced equipment trust certificates		632		950
Investor-owned utilities		558		509
Pooled debt obligations		69		90
Total Structured Finance		2,399		2,397
International Finance:
Transportation revenue		28		397
Public finance infrastructure		—		149
Other		37		40
Total International Finance		65		586
Grand Total	$	4,707	$	5,266

(1) Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. Ambac Assurance, or one of its affiliates, has insured the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.

The total number of credits with Ambac Assurance ratings below investment grade were 61 and 65 at June 30, 2007 and December 31, 2006, respectively. The increase in Structured Finance’s mortgage-backed and home equity category is due to the downgrade of three non sub-prime second lien transactions. The decrease in International Finance’s public finance infrastructure category is due to the refinancing of the Eurotunnel credit.

Structured Finance includes exposure to sub-prime residential mortgage-backed securities. Ambac has exposure to the sub-prime market through direct guarantees in our MBS portfolio, guarantees of collateralized debt obligations and, to a lesser extent, guarantees of bank sponsored multi-seller conduits that contain residential mortgage-backed securities (“RMBS”) in their collateral pool. Additionally, Ambac has issued a $3 billion commitment to provide a financial guarantee on a managed pool of CDO of asset-backed securities, mostly RMBS. Currently, this pool is primarily comprised of CDOs that were originated prior to 2006 (71%) and 83% of the pool is rated AA or better (48% rated AAA). Ambac will be afforded first loss protection consistent with other collateralized debt obligations noted below.

Sub-prime MBS Portfolio exposure:

Ambac insures tranches issued in RMBS, including transactions that contain risks to sub-prime borrowers. This means that we insure the RMBS from a given loss attachment point to the top of the capital structure. Recent downgrades by the major

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

independent rating agencies have been concentrated in the 2005-2006 vintage years of sub-prime transactions. The following tables provide details on vintage year and underlying credit rating of Ambac’s sub-prime RMBS book of business:

Vintage Year ($ In billions)	Total sub-prime RMBS net par outstanding at June 30, 2007
1998-2001	$	1.3
2002		1.3
2003		2.5
2004		0.9
2005		1.6
2006		1.1
2007		0.6
Total	$	9.3
% of Total MBS Portfolio		16.7	%

Internal Ambac credit rating*	Percent of Sub-prime RMBS Portfolio
AAA	6	%
AA	4	%
A	41	%
BBB	43	%
BIG	6	%

* Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. Ambac credit ratings are subject to revision at anytime and do not constitute investment advice. The insured RMBS in the BBB portion of the table are all relatively large senior tranches that reside at the top of the capital structure. Because of their size and position in the capital structure these tranches will produce significantly lower levels of loss severity, upon collateral default, than BBB-rated mezzanine tranches with similar collateral.

Sub-prime CDO exposure in Collateralized Debt Obligations:

Ambac’s RMBS exposure embedded in CDOs relate primarily to the asset class commonly referred to as CDO of asset backed securities or CDO of ABS. Ambac has established a minimum requirement for participation in these transactions to be a triple A rating from one or more of the major rating agencies. However, all existing transactions were executed at subordination levels that were well in excess of an initial rating agency triple A attachment point (i.e. the level of subordination that was initially required to achieve such rating). Ambac’s participation in CDO of ABS transactions is at the senior class in the capital structure. Our exposure to sub-prime RMBS embedded in CDO of ABS relates primarily to CDO of high-grade ABS transactions, but also includes mezzanine CDO of ABS transactions. Ambac’s exposures to CDO of ABS were $29.2 billion, of which $26.3 billion related to CDO of high-grade ABS.

High-grade CDO of ABS transactions are typically comprised of underlying RMBS collateral generally rated single A through triple A by one or more of the major rating agencies at the inception of the CDO. High-grade transactions contain a mix of sub-prime, mid-prime and prime mortgages. High-grade deals may contain components of other high-grade and mezzanine CDO exposure. These CDO components would also generally have single A

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

through triple A ratings. The higher investment grade ratings of the underlying collateral give rise to the term “high-grade.” Ambac’s CDO of high-grade ABS exposures have underlying collateral that consists of 39% sub-prime RMBS, 36% other RMBS and 13% mezzanine CDO exposures. The current ratings of the sub-prime RMBS collateral is 4% Aaa, 42% Aa, 50% A and 4% Baa.

Mezzanine CDO of ABS transactions are structured similar to high-grade transactions. The primary difference is that the underlying collateral exposure in a mezzanine transaction is comprised primarily of triple B rated tranches of sub-prime and mid-prime mortgages. Typically, mezzanine transactions require a more significant level of subordination to achieve triple A credit ratings because of the lower credit quality of the underlying collateral pool.

Ambac typically provides credit protection in connection with CDOs through credit default swaps that largely replicate the protection provided by financial guarantees. Credit default swaps are derivative contracts that are subject to mark to market accounting under generally accepted accounting principles even though the risks are similar to our insurance policies. Ambac has tailored its credit derivative contracts to contain certain provisions that are similar to our standard insurance contracts in order to mitigate certain liquidity risk that is inherent in standard credit derivative contracts. While derivative contracts generally provide for mark-to-market termination payments in the event a derivative transaction is terminated early, Ambac has typically limited these events to its own payment default or bankruptcy.

The two key liquidity risk mitigation terms are as follows:

• “Pay as you go” in the event of a loss - The significant majority of our credit derivatives (post 2004), including all of our CDO of ABS contracts, are written as “pay-as-you-go”. Similar to an insurance policy execution, pay-as-you-go provides that we pay interest shortfalls on the referenced transaction as they are incurred on each scheduled payment date, but only pay principal shortfalls upon the earlier of (i) the date on which all of the assets designated to fund the referenced obligation have been disposed of and all proceeds of those assets have been fully distributed to note holders and (ii) the legal final maturity date of the referenced obligation. Unlike the dealer credit derivative contract, our contracts do not give the buyer of protection the option of physical settlement.

• No collateral posting - No credit derivative transaction executed after August 2002 in connection with a CDO transaction includes ratings based collateral triggers or otherwise require Ambac to post collateral regardless of its ratings or the size of the mark to market.

32

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Public Finance:

Public Finance bond obligations par value written was $14.7 billion for the three months ended June 30, 2007, which was 18% higher than $12.5 billion of par value written in the three months ended June 30, 2006. During the six months ended June 30, 2007 par value written was $28.6 billion, which was 28% higher than $22.4 billion of par value written in the six months ended June 30, 2006. The increases were primarily due to higher overall market issuance, which were up 13% and 28% for the three and six months ended June 30, 2007, respectively, partially offset by a lower percentage of bonds issued with financial guarantee insurance. The overall market issuance for the six months of 2007 was driven by both the new money (up 21%) and refundings (up 59%) components of the market. Ambac’s market share was 20.5% and 22.3% for the three and six months ended June 30, 2007, compared to 26.5% and 24.1% for the three and six months ended June 30, 2006.

The table below shows the percentage, by bond type, of new Public Finance business gross par guaranteed by Ambac Assurance during the six months of 2007 and the full year 2006.

New Business Guaranteed by Bond Type

Bond Type	Year-to-Date 2007		Full Year 2006
Public Finance:
Lease and tax-backed revenue	28	%	34	%
General obligation	28	%	24	%
Utility revenue	15	%	11	%
Health care revenue	10	%	10	%
Higher education	8	%	9	%
Transportation revenue	7	%	6	%
Housing revenue	3	%	4	%
Other	1	%	2	%
Total Public Finance	100	%	100	%

Structured Finance:

Structured Finance obligations par value written was $19.4 billion for the three months ended June 30, 2007, which was 10% lower than $21.6 billion of par value written in the three months ended June 30, 2006. During the six months ended June 30, 2007, par value written was $34.5 billion, 11% lower compared to $38.7 billion in the six months ended June 30, 2006. The decreases in Structured Finance obligations guaranteed for the three and six months ended June 30, 2007 were primarily due to lower structured insurance, partially offset by higher pooled debt obligations and higher mortgage-backed and home equity securitizations.

33

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The table below shows the percentage, by bond type, of new Structured Finance business gross par guaranteed by Ambac Assurance during the six months of 2007 and the full year 2006.

New Business Guaranteed by Bond Type

Bond Type	Year-to-Date 2007		Full Year 2006
Structured Finance:
Pooled debt obligations	43	%	33	%
Mortgage-backed and home equity	32	%	30	%
Asset-backed and conduits	18	%	25	%
Investor-owned utilities	4	%	4	%
Student loan	3	%	5	%
Other	<1	%	3	%
Total U.S. Structured Finance	100	%	100	%

International Finance:

International Finance bond obligations par value written was $4.9 billion for the three months ended June 30, 2007, which was 33% lower than $7.3 billion of par value written for the three months ended June 30, 2006. During the six months ended June 30, 2007, par value written was $7.5 billion, which was 13% lower than $8.6 billion of par value written for the six months ended June 30, 2006. The decreases in International Finance obligations guaranteed during the three and six months ended June 30, 2007 were primarily due to lower sovereign/sub-sovereign obligations, pooled debt obligations and investor-owned and public utility obligations, partially offset by higher asset-backed and conduits and higher mortgage-backed securitizations.

The table below shows the percentage, by bond type, of new International Finance business gross par guaranteed by Ambac Assurance during the six months of 2007 and the full year 2006.

New Business Guaranteed by Bond Type

Bond Type	Year-to-Date 2007		Full Year 2006
International Finance:
Asset-backed and conduits	42	%	25	%
Pooled debt obligations	23	%	36	%
Investor-owned and public utilities	12	%	12	%
Mortgage-backed and home equity	10	%	3	%
Sovereign/sub-sovereign	5	%	15	%
Transportation	3	%	6	%
Other	5	%	3	%
Total International Finance	100	%	100	%

34

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Gross Premiums Written. Gross premiums written for the three and six months ended June 30, 2007 were $261.1 million and $511.0 million, respectively, a decrease of $52.4 million or 17% from $313.5 million in the three months ended June 30, 2006 and a decrease of $21.6 million or 4% from $532.6 million in the six months ended June 30, 2006.

Up-front premiums written during the three and six months ended June 30, 2007 were $125.8 million and $238.1 million, respectively, a decrease of 27% from $173.4 million in the three months ended June 30, 2006 and a decrease of 12% from $270.2 million in the six months ended June 30, 2006. Up-front premiums written in the second quarter of 2007 saw decreases in both Public and International Finance sector, partially offset by a slight gain in the Structured Finance sector. The first six months of 2007 saw decreases in both Structured and International Finance, partially offset by an increase in Public Finance.

Installment premiums written for the three and six months ended June 30, 2007 were $135.3 million and $272.9 million, respectively, a decrease of 3% from $140.1 million in the three months ended June 30, 2006, and an increase of 4% from $262.4 million in the six months ended June 30, 2006. Installment premiums written in the second quarter of 2007 saw decreases in Structured Finance and International Finance, partially offset by an increase in Public Finance, while the first six months of 2007 saw increases in all three market sectors - Public, Structured and International Finance.

The following table sets forth the amounts of gross premiums written by type for the three and six months ended June 30, 2007 and 2006:

	Three Months Ended June 30,				Six Months Ended June 30,
	2007		2006		2007		2006
Public Finance:
Up-front	$	105.0	$	116.6	$	211.1	$	201.0
Installment		6.7		6.3		15.0		14.2
Total Public Finance		111.7		122.9		226.1		215.2
Structured Finance:
Up-front		11.9		11.5		16.3		16.8
Installment		75.6		78.7		154.5		152.2
Total Structured Finance		87.5		90.2		170.8		169.0
International Finance:
Up-front		8.9		45.3		10.7		52.4
Installment		53.0		55.1		103.4		96.0
Total International Finance		61.9		100.4		114.1		148.4
Total	$	261.1	$	313.5	$	511.0	$	532.6
Total up-front	$	125.8	$	173.4	$	238.1	$	270.2
Total installment		135.3		140.1		272.9		262.4
Total	$	261.1	$	313.5	$	511.0	$	532.6

Reinsurance. Ambac Assurance’s reinsurance program is principally comprised of a surplus share treaty and facultative reinsurance. The surplus share treaty requires Ambac Assurance to cede covered transactions while affording Ambac Assurance the flexibility to cede par amounts of such transactions within a predefined range. Management uses facultative reinsurance to cede risks in amounts greater than the maximums that can be ceded under the surplus share treaty and risks which are excluded from the surplus share treaty. Ceded

35

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

premiums written for the three and six months ended June 30, 2007 were $28.4 million and $57.9 million, respectively, a decrease of $29.3 million or 51% from $57.7 million in the three months ended June 30, 2006 and an increase of $8.9 million or 18% from $49.0 million in the six months ended June 30, 2006.

Included in ceded premiums written in the six months ended June 30, 2006 is $37.0 million in return premiums from reinsurance contracts that were cancelled. Excluding the return premiums from the six months ended June 30, 2006, ceded premiums written were $86.0 million. For the six months ended June 30, 2007, ceded premiums written decreased 33% compared with the six months ended June 30, 2006 after excluding the return premiums. Ceded premiums as a percentage of gross premiums written were 10.9% and 18.4% for the second quarter of 2007 and 2006. Ceded premiums (exclusive of the return premiums) as a percentage of gross premiums written were 11.3% and 16.2% for the six months ended June 30, 2007 and 2006, respectively. The decline in ceded written premiums as a percentage of gross written premiums written for the quarter and six months ended June 30, 2007 (exclusive of the return premiums) was attributable to the underwriting of larger public finance and international transactions during the quarter ended June 30, 2006.

Net Premiums Earned and Other Credit Enhancement Fees. Net premiums earned and other credit enhancement fees for the three and six months ended June 30, 2007 were $238.3 million and $469.9 million, an increase of 6% from $225.0 million for the three months ended June 30, 2006 and an increase of 8% from $433.4 million for the six months ended June 30, 2006. The increases were primarily the result of higher refundings and calls of previously insured obligations and other accelerations, such as reinsurance cancellations, (collectively referred to as “accelerated earnings”), higher normal premiums earned (which is defined as net premiums earned less accelerated earnings and reconciled to total net premiums earned in the table below) and higher other credit enhancement fees.

The following table provides a breakdown of net premiums earned by market sector and other credit enhancement fees:

	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in Millions)	2007		2006		2007		2006
Public Finance	$	59.1	$	58.1	$	117.4	$	114.0
Structured Finance		74.0		70.6		145.8		139.9
International Finance		44.9		44.8		91.0		88.9
Total normal premiums earned		178.0		173.5		354.2		342.8
Accelerated earnings		43.0		37.3		82.8		62.3
Total net premiums earned		221.0		210.8		437.0		405.1
Other credit enhancement fees		17.3		14.2		32.9		28.3
Total net premiums earned and other credit enhancement fees	$	238.3	$	225.0	$	469.9	$	433.4

Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. However, given the same underlying attributes of an insured obligation such as tenor, gross premium amount, and amortization schedule, the timing of revenue recognition may differ for premiums collected upfront versus premiums collected in installments. When an issue insured by Ambac Assurance has been refunded or called, any remaining unearned premium (net of refunding credits, if any) is earned at that time. The level of refundings or calls vary, depending upon a number of conditions,

36

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

primarily the relationship between current interest rates and interest rates on outstanding debt. Earnings on refundings typically relate to transactions where the premium was paid up-front at the inception of the policy. Accelerated earnings also include the difference between negotiated return premiums and the associated unearned premium on reinsurance cancellations. Net premiums earned during the three and six months ended June 30, 2007 included $43.0 million and $82.8 million, respectively, from accelerated earnings as compared to $37.3 million and $62.3 million for the three and six months ended June 30, 2006, respectively. The following table provides a breakdown of accelerated earnings:

	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in Millions)	2007		2006		2007		2006
Public Finance	$	31.6	$	23.9	$	65.2	$	39.6
Structured Finance		4.2		10.0		5.1		11.5
International Finance		7.2		3.4		12.5		3.5
Reinsurance Cancellations		—		—		—		7.7
Total accelerated earnings	$	43.0	$	37.3	$	82.8	$	62.3

Normal net premiums earned increased 3% from $173.5 million in the second quarter of 2006 to $178.0 million in the second quarter of 2007. Normal net premiums earned for the six months ended June 30, 2007 were $354.3 million, an increase of 3% from $342.8 million in the six months ended June 30, 2006. Normal net premiums earned for the three months ended June 30, 2007 increased 2% for Public, 5% for Structured, and <1% for International Finance, respectively, from the three months ended June 30, 2006. Normal net premiums earned for the six months ended June 30, 2007 increased 3% for Public Finance, 4% for Structured Finance and 2% for International Finance, from the six months ended June 30, 2006. Public Finance normal earned premium growth has been negatively impacted by the high level of refunding activity over the past two years, competitive pricing and the mix of business underwritten in recent periods. The growth in normal earned premiums in Structured Finance was driven by strong business production in asset classes such as pooled debt obligations and commercial asset-backed securities over the past several quarters. The decrease in the level of growth in International Finance normal earned premium has resulted from deal terminations and a slow down in deal closings in 2007 relative to the prior year.

Other credit enhancement fees, which is primarily comprised of fees received from the structured credit derivatives product were $17.3 million and $32.9 million for the three and six months ended June 30, 2007, respectively, an increase of 22% from $14.2 million in the three months ended June 30, 2006 and an increase of 16% from $28.3 million in the six months ended June 30, 2006. The increases are primarily due to higher domestic credit derivative writings.

Net Investment Income. Net investment income for the three and six months ended June 30, 2007 was $113.2 million and $225.3 million, increases of 8% from $104.5 million in the three months ended June 30, 2006 and an increase of 9% from $206.2 million in the six months ended June 30, 2006. The increases were primarily attributable to the growth of the investment portfolio resulting from the positive operating cash flows of the Financial Guarantee book of business (primarily premiums written and coupon receipts on invested assets). Investments in tax-exempt securities amounted to 77% and 74% of the total fair value of the Financial Guarantee portfolio as of June 30, 2007 and June 30, 2006, respectively. The average pre-tax yield-to-maturity on the investment portfolio was 4.61% at June 30, 2007 compared with 4.63% at June 30, 2006.

37

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Net Mark-to-Market (Losses) Gains on Credit Derivative Contracts. Net mark-to-market (losses) on credit derivative contracts for the three and six months ended June 30, 2007 were ($56.9) million and ($62.0) million, respectively, compared to net mark-to-market gains of $5.4 million and $7.3 million in the three and six months ended June 30, 2006, respectively. During the second quarter of 2007, a net mark-to-market loss was recorded related to collateralized debt obligations of asset-backed securitizations (“CDO of ABS”) containing sub-prime mortgage-backed securities as collateral. The negative mark-to-market is driven by current market concerns over the most recent vintages of sub-prime residential mortgage-backed securities and the recent lack of liquidity in collateralized debt obligations of the asset–backed security market resulting in a reduction in market-quoted prices. Ambac’s exposure on those transactions all attach at levels senior to the triple-A attachment points as established by the rating agencies. There were no realized net losses paid on credit derivatives for the three and six months ended June 30, 2007 and 2006. At the end of July 2007, we have noted a continued widening of credit spreads across the credit derivative portfolio, particularly CDO of ABS and collateralized loan obligations, resulting in additional mark-to-market unrealized losses.

Other Income. Other income for the three and six months ended June 30, 2007 was $5.6 million and $8.5 million, respectively, compared to other income of $3.5 million and $32.4 million for the three and six months ended June 30, 2006, respectively. During the first quarter of 2006, Ambac Assurance sold three aircraft from a previously reported defaulted enhanced equipment trust certificate. The gain on the sale amounted to $25.0 million. Also included within other income are structuring fee revenues for the three and six months ended June 30, 2007 of approximately $0.4 million and $1.1 million, respectively, compared to $0.9 million and $1.1 million in the three and six months ended June 30, 2006, respectively. Structuring fees are negotiated for certain domestic and international structured finance transactions, typically collected at inception of the transactions, and are earned ratably over the life of the transactions. Ambac has approximately $14.4 million and $14.8 million of deferred structuring fees included in “Other liabilities” on the Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006, respectively.

Loss and Loss Expenses. Loss and loss expenses are based upon estimates of the aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. Loss and loss expenses for the three and six months ended June 30, 2007 were $17.1 million and $28.5 million, respectively, compared to $12.8 million and $12.9 million for the three and six months ended June 30, 2006. The increased loss provisions in 2007 are primarily the result of increases for domestic transportation and residential mortgage-backed security sectors, partially offset by a reduction in the remaining Public Finance portfolio due to improved financial conditions.

38

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The following table summarizes the changes in the total net loss reserves for the six months ended June 30, 2007 and the year-ended December 31, 2006:

(Dollars in millions)	June 30, 2007			December 31, 2006
Beginning balance of net loss reserves	$	215.0		$	300.6
Provision for losses and loss expenses		28.5			20.0
Losses paid		(15.5	)		(126.2	)
Recoveries of losses paid from reinsurers		0.4			3.9
Other recoveries, net of reinsurance		22.6			16.7
Ending balance of net loss reserves	$	251.0		$	215.0

The following tables provide details of net losses paid, net of recoveries received for the six months ended June 30, 2007 and 2006 and gross case basis credit reserves and total gross loss reserves at June 30, 2007 and December 31, 2006:

(Dollars in millions)	June 30, 2007			June 30, 2006
Net losses paid (recovered):
Public Finance	$	(7.9	)	$	5.9
Structured Finance		(0.9	)		23.0
International Finance		1.2			(1.1	)
Total	$	(7.6	)	$	27.8

	June 30, 2007						December 31, 2006
(Dollars in millions)	Gross Case Basis Reserves(1)(2)			Total Loss Reserves(3)			Gross Case Basis Reserves(1)(2)			Total Loss Reserves
Public Finance	$	50.6		$	229.1		$	45.7		$	195.0
Structured Finance		5.3			30.5			(0.2	)		21.6
International Finance		(3.8	)		(3.8	)		2.0			3.5
Total	$	52.1		$	255.8		$	47.5		$	220.1

⁽¹⁾ Ambac discounts estimated net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio. Discount rates applied to case basis credit reserves were 4.5% at June 30, 2007 and at December 31, 2006.

⁽²⁾ Reinsurance recoverables on case basis credit reserves were $4.9 million and $5.0 million at June 30, 2007 and December 31, 2006, respectively.

⁽³⁾ Included in the calculation of active credit reserves at June 30, 2007 and December 31, 2006 was the consideration of $11.9 million and $6.9 million, respectively, of reinsurance which would be due to Ambac Assurance from the reinsurers, upon default of the insured obligations.

Active credit reserves were $203.7 million and $172.6 million at June 30, 2007 and December 31, 2006, respectively. The active credit reserve at June 30, 2007 and December 31, 2006 was comprised of 46 and 55 credits with net par outstanding of $3,223.6 million and $3,831 million, respectively. The decrease in net par outstanding of credits within the active credit reserve was driven primarily by exposure paydowns and transfers to case basis credit reserves, offset by downgrades in the non sub-prime residential mortgage-backed security sector. During the second quarter of 2007, one sub-prime residential mortgage-backed transaction defaulted. Net par outstanding for this transaction was $5.0 million at June 30, 2007.

39

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Case basis credit reserves at June 30, 2007 and December 31, 2006 were comprised of 7 credits, with net par outstanding of $495.2 million and $668.4 million, respectively. The decrease in case basis credit reserves net par is primarily due to the refinancing of the Eurotunnel credit, which was finalized during the second quarter 2007 and recoveries were received related to claim payments previously paid.

At June 30, 2007, the expected future claim payments on credits that have already defaulted, totaled $195.4 million. Related future payments are $5.4 million, $0.3 million, $0.3 million, $1.5 million and $2.8 million for the remainder of 2007, 2008, 2009, 2010 and 2011, respectively.

Please refer to the “Critical Accounting Policies and Estimates” section of this Management’s Discussion and Analysis and to Note 3 of the Consolidated Financial Statements for further background information on loss reserves, our policy and for further explanation of potential changes.

Underwriting and Operating Expenses. Underwriting and operating expenses for the three and six months ended June 30, 2007 were $33.4 million and $69.8 million, respectively, an increase of 5% from $31.9 million in the three months ended June 30, 2006 and was flat compared to $69.7 million in the six months ended June 30, 2006. Underwriting and operating expenses consist of gross underwriting and operating expenses, less the deferral to future periods of expenses and reinsurance commissions related to the acquisition of new insurance contracts, plus the amortization of previously deferred expenses and net reinsurance commissions. The following table provides details of underwriting and operating expenses for the three and six months ended June 30, 2007 and 2006:

	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in Millions)	2007			2006			2007			2006
Gross underwriting and operating expenses	$	48.9		$	45.5		$	98.1		$	98.3
Net reinsurance commissions received (1)		(7.5	)		(14.4	)		(15.6	)		(10.9	)
Operating expenses and reinsurance commissions deferred (1)		(18.0	)		(12.0	)		(35.6	)		(34.3	)
Amortization of previously deferred expenses (1)		10.0			12.8			22.9			16.6
Underwriting and operating expenses	$	33.4		$	31.9		$	69.8		$	69.7

(1) The 2006 cancellations of reinsurance contracts disclosed above impacted net reinsurance commissions received by ($10.3) million and the amortization of previously deferred expenses by $8.1 million.

The increase in gross underwriting expenses for the three months ended June 30, 2007 was primarily due to the acceleration of stock compensation expense recognized for grants which vested during the quarter. Gross underwriting expenses for the six months ended June 30, 2007 and 2006 remained fairly consistent year over year.

Financial Guarantee Exposure Draft (“ED”). On April 18, 2007, the FASB issued an ED for public comment entitled “Accounting for Financial Guarantee Insurance Contracts”, an interpretation of SFAS 60 “Accounting and Reporting by Insurance Enterprises”. The proposals contained within the ED are not considered final accounting guidance until the FASB completes its public due process procedures, which is expected to conclude in the first quarter 2008. The FASB’s due process procedures include obtaining the comments from its constituency, including preparers of financial statements, users of financial statements such as investors and

40

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

rating agencies, and other interested parties such as auditors and regulators. The comment period ended on June 18, 2007 and a roundtable with interested parties is expected to be held in 2007.

Under the ED, Ambac would be required to recognize premium revenue, for both upfront and installment paying policies, in proportion to the insured contractual principal and interest payments made by the issuer of the insured financial obligation, rather than being recognized over the term of each maturity for upfront paying policies, or over the installment period for such policies. This change would generally result in a volatile revenue recognition pattern over the life of the insured obligation as premium would only be recognized as the insured obligation’s principal or interest is paid. Furthermore, for certain bonds such as investor-owned utilities, CDOs and many other types of asset-backed securities that do not have periodic payments, this change would result in significantly slower revenue recognition. The volatility would be most evident for insured securities whereby the principal payments are made at maturity but would also impact insured securities with customized amortization schedules. Furthermore, the majority of our insured public finance book of business has semi-annual principal and interest payments, which would cause uneven revenue recognition throughout each calendar year. For installment paying policies, the ED requires that the discount, equating to the difference between gross installment premiums and the present value of installment premiums, be recognized as investment income rather than premiums.

While certain provisions of the ED are still being analyzed, Ambac believes that the cumulative effect of initially applying the revenue recognition provisions of this ED to our upfront paying policies would be material to our financial statements. Additionally, the revenue recognition for insurance transactions originated after the standard’s effective date would be materially different than our current premium revenue recognition methodology. Ambac continues to evaluate the implications of the ED with regard to income recognition on installment paying policies, claim liabilities and deferred acquisition costs on its financial statements.

Financial Services Segment

Through its Financial Services subsidiaries, Ambac provides financial and investment products including investment agreements, funding conduits, interest rate swaps, currency swaps and total return swaps. The investment agreement business is managed with the goal of closely matching the cash flows of the investment agreement liabilities with the cash flows of the related investment portfolio. To achieve this goal, derivative contracts may be used. The primary activities in the derivative products business are intermediation of interest rate and currency swap transactions and taking total return swap positions on certain fixed income obligations. Most of the swap intermediation is done on a fully hedged basis with the exception of certain municipal interest rate swaps that are not hedged for the basis difference between taxable and tax-exempt interest rates. As such, changes in the relationship between taxable and tax-exempt interest rates will result in mark-to-market gains or losses.

Revenues. Revenues for the three and six months ended June 30, 2007 were $110.0 million and $228.5 million, a decrease of 24% from $144.6 million in the three months ended June 30, 2006 and a decrease of 6% from $242.2 million in the six months ended June 30, 2006.

41

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The following table provides a breakdown of Financial Services revenues for the three and six months ended June 30, 2007 and 2006:

(Dollars in Millions)	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
Investment income	$	107.9		$	98.1		$	213.9		$	180.0
Derivative products		2.5			3.3			6.1			8.0
Net realized investment gains		0.3			41.7			6.5			47.2
Net mark-to-market (losses) gains on total return swaps		(1.0	)		1.8			2.2			7.1
Net mark-to-market (losses) gains on non-trading derivative contracts		0.3			(0.3	)		(0.2	)		(0.1	)
Total Financial Services revenue	$	110.0		$	144.6		$	228.5		$	242.2

The increase in investment income for the three and six months ended June 30, 2007 was driven by higher rates on a larger portfolio of floating rate investments in the investment agreement business. The total return swap portfolio has experienced net mark-to-market losses for the second quarter of 2007 and lower net mark-to-market gains for the six months ended June 30, 2007 as a result of credit spread widening relative to the three and six months ended June 30, 2006.

Prior to 2004, realized losses included an impairment write-down of $150.2 million related to asset-backed notes issued by National Century Financial Enterprises, Inc (“NCFE”). These notes, which were backed by health care receivables and rated triple-A until October 25, 2002, defaulted and NCFE filed for protection under Chapter 11 of the U.S. Bankruptcy Code in November 2002. The loss was specific to the NCFE notes and had no impact on other investments held. Ambac has received cash recoveries of $90.3 million through June 30, 2007 resulting from distributions under the NCFE Bankruptcy Plan, payments made by a trust created under the Plan and litigation settlements. Included in those recoveries are $0 and $6.2 million received during the three and six months ended June 30, 2007, respectively, compared to $38.2 million and $44.1 million received during the three and six months ended June 30, 2006, respectively.

Expenses. Expenses for the three and six months ended June 30, 2007 were $104.2 million and $206.5 million, respectively, up 11% from $93.8 million in the three months ended June 30, 2006 and up 20% from $172.4 million in the six months ended June 30, 2006. Included in the above are interest expenses related to investment and payment agreements of $101.1 million and $200.1 million for the three and six months ended June 30, 2007, respectively, and $90.5 million and $165.5 million for the three and six months ended June 30, 2006, respectively. The increase was primarily related to higher rates on a larger portfolio of floating rate investment agreements, partially offset by runoff of fixed rate investment agreements.

Corporate Items

Interest Expense. Interest expense for the three and six months ended June 30, 2007 was $22.1 million and $41.4 million, respectively, up 13% from $19.5 million in the three months ended June 30, 2006 and up 6% from $39.0 million in the six months ended June 30, 2006. The increase is primarily attributable to the completed public offering of $400 million aggregate principal amount of Directly Issued Subordinated Capital Securities (the “DISCs”) on February 12, 2007, partially offset by the October 2006 redemption of Ambac’s $200 million 7% debentures.

42

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Provision for Income Taxes. Income taxes for the three and six months ended June 30, 2007 were at an effective rate of 25.4% and 25.9%, respectively, compared to 27.0% and 26.9% for the three and six months ended June 30, 2006, respectively. The decreases in the effective tax rates for the three and six months ended June 30, 2007 is primarily due to a decrease in taxable underwriting profits as compared to tax-exempt income.

Liquidity and Capital Resources

Ambac Financial Group, Inc. Liquidity. Ambac’s liquidity, both on a short-term basis (for the next twelve months) and a long-term basis (beyond the next twelve months), is largely dependent upon: (i) Ambac Assurance’s ability to pay dividends or make other payments to Ambac; and (ii) external financings. Pursuant to Wisconsin insurance laws, Ambac Assurance may pay dividends, provided that, after giving effect to the distribution, it would not violate certain statutory surplus, solvency and asset tests. Based upon this test, the maximum amount that will be available during 2007 for payment of dividends without regulatory approval by Ambac Assurance is $370.0 million. Additionally, no quarterly dividend may exceed the dividend paid in the corresponding quarter of the preceding year by more than 15% without notifying the Wisconsin Insurance Commissioner 30 days in advance of payment. Ambac Assurance paid dividends of $95.1 million and $68.0 million during the six months ended June 30, 2007 and 2006. Ambac sought and obtained regulatory approval with respect to the dividends paid in each of the first and second quarters of 2007, which exceeded by more than 15% the dividends paid in the first and second quarters of 2006, respectively.

Pursuant to a tax sharing agreement, Ambac’s subsidiaries are included in Ambac’s consolidated Federal income tax return. The agreement provides for the determination of tax expense or benefit based upon the contribution of Ambac’s subsidiaries to Ambac’s consolidated Federal income tax liability. The tax liability is settled quarterly, with a final settlement taking place after the filing of the consolidated Federal income tax return.

Ambac’s principal uses of liquidity are for the payment of its operating expenses, income taxes, interest on its debt, dividends on its shares of common stock, purchases of its common stock in the open market and capital investments in its subsidiaries.

Based on the amount of dividends that it expects to receive from Ambac Assurance and other subsidiaries during 2007, management believes that Ambac will have sufficient liquidity to satisfy its needs over the next twelve months, including the ability to pay dividends on its common stock in accordance with its dividend policy. Beyond the next twelve months, Ambac Assurance’s ability to declare and pay dividends to Ambac may be influenced by a variety of factors including adverse market changes, insurance regulatory changes and changes in general economic conditions. Consequently, although management believes that Ambac will continue to have sufficient liquidity to meet its debt service and other obligations over the long term, no guarantee can be given that Ambac Assurance will be able to dividend amounts sufficient to pay all of Ambac’s operating expenses, debt service obligations and dividends on its common stock.

A subsidiary of Ambac Financial Group provides a $360 million liquidity facility to a reinsurance company which acts as reinsurer with respect to a portfolio of life insurance

43

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

policies. The liquidity facility, which is guaranteed by Ambac Assurance, provides temporary funding in the event that the reinsurance company’s capital is insufficient to make payments under the reinsurance agreement. The reinsurance company is required to repay all amounts drawn under the liquidity facility. No amounts have been drawn under this facility at June 30, 2007.

Ambac Assurance Liquidity. The principal uses of Ambac Assurance’s liquidity are the payment of operating expenses, claim payments, reinsurance premiums, taxes, dividends to Ambac and capital investments in its subsidiaries. Management believes that Ambac Assurance’s operating liquidity needs can be funded exclusively from its operating cash flow. The principal sources of Ambac Assurance’s liquidity are gross premiums written, scheduled investment maturities, net investment income and receipts from credit derivatives.

Financial Services Liquidity. The principal uses of liquidity by Financial Services subsidiaries are payment of investment and payment agreement obligations pursuant to defined terms, net obligations under interest rate, total return and currency swaps, operating expenses and income taxes. Management believes that its Financial Services liquidity needs can be funded from its operating cash flow, the maturity of its invested assets and from time to time, by short-term inter-company loans and repurchase agreement transactions. The principal sources of this segment’s liquidity are proceeds from issuance of investment agreements, net investment income, maturities of securities from its investment portfolio (which are invested with the objective of closely matching the cash flows of its obligations under the investment agreements) and net receipts from interest rate, currency and total return swaps. The investment objectives with respect to investment agreements are to achieve the highest after-tax total return, subject to a minimum average quality rating of AA on invested assets, and to maintain a liquid floating rate investment portfolio, which includes short-term investments, to minimize interest rate and liquidity risk. As of June 30, 2007, the investment agreement business floating rate investment portfolio approximates $6.5 billion or 85% of the investment portfolio related to the investment agreement business.

Investment agreements subject Ambac to liquidity risk associated with unscheduled withdrawals of principal allowed by the terms of the investment agreements. Ambac manages liquidity risk by characterizing our investment agreements into two broad categories, contingent and fixed. Contingent draw transactions include contractual provisions that allow the investor to withdraw principal and require minimal notice to Ambac. The vast majority of these investment agreements can only be drawn in the event that well-defined, observable events have occurred, primarily credit events. As of June 30, 2007, approximately $4.5 billion relates to contingent draw investment agreements. In addition, many of these contracts contain lock-out periods where unscheduled withdrawals are restricted and provisions which compensate Ambac for break-costs resulting from early withdrawal. As of June 30, 2007, approximately $0.7 billion of contingent draw investment agreements include provisions where our counterparty has the option to withdraw funds prior to maturity during 2007. Fixed draw investment agreements have few provisions for unscheduled withdrawals, however, if permitted, the events triggering the withdrawal are deemed to be remote, require advance notification to Ambac and most often include provisions that compensate Ambac for break costs. As of June 30, 2007, approximately $3.2 billion relates to fixed draw investment agreements, of which $1.6 billion include provisions where under remote circumstances our counterparty has the ability to withdraw funds during 2007.

44

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Credit Ratings and Collateral. Downgrades in Ambac Assurance’s triple-A financial strength rating would adversely affect Ambac’s ability to compete for business. Credit ratings are an important component of a financial institutions’ ability to compete in the financial guarantee, derivative, investment agreement and structured transaction markets. In the event that Ambac Assurance is downgraded, Ambac may be required to post incremental collateral to its investment agreement and derivative counterparties, introducing liquidity risk. In addition, most investment agreements provide certain remedies, including a termination of the investment agreement contract in the event of a downgrade of Ambac Assurance’s credit rating, typically to A1 by Moody’s or A+ by S&P. In most cases Ambac is permitted to post collateral or otherwise enhance its credit, prior to an actual draw on the investment agreement.

The financial services business executes a range of interest rate and cross-currency swaps to reduce the market risk on investment agreements with Ambac’s derivatives subsidiary, Ambac Financial Services, LLC. In addition, Ambac Financial Services provides interest rate and currency swap transactions for states, municipalities, asset-backed issuers and other entities in connection with their financings. Ambac Financial Services offsets most of the interest rate and currency risks in these instruments and incorporates these transactions under standardized derivative documents including collateral support agreements. Under these agreements, Ambac could be required to post collateral to a swap dealer in the event unrealized losses exceed a predetermined threshold amount. Ambac has posted collateral of $0.7 million under these contracts at June 30, 2007. Conversely, Ambac could receive collateral from the counterparty in the event unrealized gains exceed a predetermined threshold. Ambac has received collateral of $245.3 million under these contracts at June 30, 2007. The thresholds afforded Ambac by the swap dealer would be reduced in the event of a downgrade of Ambac’s credit rating. The reduction in the threshold could result in Ambac posting additional amounts of collateral to the counterparty.

Ambac Capital Services enters into total return swaps and Ambac Credit Products enters into credit derivative contracts. All of our total return swaps and a small portion of our credit derivatives have collateral support agreements. In addition, a downgrade of our financial strength rating below specified levels would allow credit derivative counterparties to terminate certain agreements, resulting in a possible payment of a settlement amount or we would have to pledge collateral for the benefit of the counterparty. At June 30, 2007, Ambac has not pledged collateral under any of its credit derivative or total return swap contracts.

Ambac manages this liquidity risk through the maintenance of liquid collateral and bank liquidity facilities. Additionally, Ambac generally has the right to re-hypothecate collateral that it receives under derivative contracts to counterparties.

Credit Facilities. On July 30, 2007, Ambac and Ambac Assurance, as borrowers, extended its $400 million five year unsecured, committed revolving credit facility (the “Credit Facility”) with a group of highly rated banks (the “Banks”) from July 28, 2011 to July 30, 2012. The Credit Facility provides for borrowings by Ambac and Ambac Assurance on a revolving basis up to an aggregate of $400 million at any one time outstanding, which maximum amount may, at Ambac’s and Ambac Assurance’s request and subject to the terms and conditions of the facility, be increased up to $500 million.

Ambac and/or Ambac Assurance may borrow under the Credit Facility for general corporate purposes, including the payment of claims. Subject to the terms and conditions

45

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

thereof, Ambac and/or Ambac Assurance may borrow under the Credit Facility until the final maturity date. Loans may be denominated in U. S. Dollars or certain other currencies at the option of Ambac and/or Ambac Assurance. Ambac and/or Ambac Assurance has the option of selecting either (i) a Base Rate, a fluctuating rate equal to the higher of Citibank’s Base Rate and the Federal Funds Rate plus 0.5%, plus the Applicable Margin (as defined in the Credit Facility) or (ii) a Eurocurrency Rate, a periodic fixed rate equal to LIBOR plus the Applicable Margin. There are no outstanding loans under the Credit Facility. Neither Ambac nor Ambac Assurance have previously incurred any borrowing under this or prior similar facilities.

The Credit Facility contains customary representations, warranties and covenants for this type of financing, including two financial covenants requiring Ambac to: (i) maintain as of the end of each fiscal quarter a debt-to-capital ratio, excluding debt consolidated under FIN 46, the DISCs and credit link notes, of not more than 30%, and (ii) maintain at all times total stockholders’ equity equal to or greater than $2.9 billion. The stockholders’ equity financial covenant will increase annually, in an amount equal to 15% of the prior fiscal year’s net income and 15% of the net proceeds of any future equity issuances. The Credit Facility also provides for certain events of default with corresponding grace periods, including failure to pay any principal or interest when due, failure to comply with covenants, any material representation or warranty made by Ambac or Ambac Assurance proving to be false in any material respect, certain bankruptcy, insolvency or receivership events affecting Ambac or Ambac Assurance, defaults relating to other indebtedness, imposition of certain judgments and a change in ownership of Ambac and/or Ambac Assurance. Ambac and Ambac Assurance are in full compliance with the terms and conditions of the Credit Facility.

Capital Support. Ambac Assurance has a series of perpetual put options on its own preferred stock. The counterparty to these put options are trusts established by a major investment bank. The trusts were created as a vehicle for providing capital support to Ambac Assurance by allowing it to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put option were exercised, Ambac Assurance would receive up to $800 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose, including the payment of claims. The preferred stock would give investors the rights of an equity investor in Ambac Assurance. Such rights are subordinate to insurance claims, as well as to the general unsecured creditors of Ambac Assurance. Dividend payments on the preferred stock are cumulative, subject to certain limited exceptions, only if Ambac Assurance pays dividends on its common stock. Each trust is restricted to holding high-quality short-term commercial paper investments to ensure that it can meet its obligations under the put option. To fund these investments, each trust has issued its own auction market perpetual securities. Each trust is rated AA/Aa2 by Standard & Poor’s and Moody’s, respectively. During the six months ended June 30, 2007 and 2006, Ambac Assurance incurred fees related to these perpetual put options of $1.7 million and $1.9 million, respectively. These fees are included as Corporate expenses on the Consolidated Statements of Operations.

From time to time, Ambac accesses the capital markets to support the growth of its businesses. In February 2006, Ambac filed a Form S-3 with the SEC utilizing a “shelf” registration process for well known seasoned issuers. Under this process, Ambac may issue through February 2009 an unlimited amount of the securities described in the prospectus filed as part of the registration, namely, common stock, preferred stock, debt securities, and warrants of Ambac.

46

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

On February 12, 2007, Ambac Financial Group completed the public offering of $400 million aggregate principal amount of DISCs due 2087. The proceeds from the sale of the DISCs was used to repurchase $400 million of Ambac’s common stock pursuant to an accelerated share repurchase program. The total number of common stock purchased under the agreement amounted to 4,459,223 shares, including 203,506 shares during the second quarter.

In connection with the completion of the DISCs Offering, Ambac entered into a replacement capital covenant for the benefit of persons that buy, hold or sell a specified series of long-term indebtedness of Ambac (“DISCs Covered Debt”).

The DISCs replacement capital covenant provides that Ambac will not repay, redeem or purchase, and will cause its subsidiaries not to repay, redeem or purchase, all or any part of the DISCs on or before February 7, 2067, except, with certain limited exceptions, to the extent that, during a specified period prior to the date of that repayment, redemption or purchase, Ambac has received proceeds from the sale of replacement capital securities.

As of the date of this 10-Q, the Ambac 5.95% Debentures due 2035, CUSIP No. 023139AE8, constitutes DISCs Covered Debt whose holders are entitled to the benefits of the DISCS Replacement Capital Covenant.

Balance Sheet. Total assets as of June 30, 2007 were $21.06 billion, up 4% compared to total assets of $20.27 billion at December 31, 2006. The increase was driven by cash generated from operations during the period, partially offset by a decrease in unrealized gain in the investment portfolio due to a rise in long-term interest rates. As of June 30, 2007, stockholders’ equity was $6.04 billion, a 2% decrease from year-end 2006 stockholders’ equity of $6.18 billion. The decrease was primarily the result of the $400 million share buyback mentioned above and lower Accumulated Other Comprehensive Income driven by higher long-term interest rates, partially offset by net income during the period.

Ambac Assurance’s investment objectives for the Financial Guarantee portfolio are to maintain an investment duration that closely approximates the expected duration of related financial guarantee liabilities and achieve the highest after-tax net investment income. The Financial Guarantee investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits.

The Financial Services investment portfolio consists primarily of assets funded with proceeds from the issuance of investment agreement liabilities. The investment objectives with respect to investment agreements are to achieve the highest after-tax total return, subject to a minimum average credit quality rating of Aa/AA on invested assets, and to maintain cash flow matching of invested assets to funded liabilities to minimize interest rate and liquidity exposure. The investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits.

47

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The amortized cost and estimated fair value of investments in fixed income securities and short-term investments at June 30, 2007 and December 31, 2006 were as follows:

	June 30, 2007				December 31, 2006
(Dollars in millions)	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Fixed income securities:
Municipal obligations	$	8,317.9	$	8,391.0	$	7,891.4	$	8,126.8
Corporate obligations		757.0		771.3		692.0		719.6
Foreign obligations		298.7		308.6		269.8		276.8
U.S. government obligations		48.9		48.2		177.2		174.0
U.S. agency obligations		729.4		743.0		757.9		789.4
Mortgage and asset-backed securities		7,114.1		7,123.7		6,696.0		6,713.7
Short-term		292.0		292.0		311.8		311.8
Other		38.7		39.9		13.4		14.4
		17,596.7		17,717.7		16,809.5		17,126.5
Fixed income securities pledged as collateral:
U.S. government obligations		105.9		100.7		—		—
U.S. agency obligations		16.1		15.6		—		—
Mortgage and asset-backed securities		171.9		169.3		311.5		307.1
		293.9		285.6		311.5		307.1
Total	$	17,890.6	$	18,003.3	$	17,121.0	$	17,433.6

The following table represents the fair value of mortgage-backed securities guaranteed by either a U.S. government agency or U.S. government sponsored enterprise at June 30, 2007 and December 31, 2006 by segment:

(Dollars in millions)	Financial Guarantee		Financial Services		Corporate		Total
June 30, 2007:
Government National Mortgage Association	$	7.2	$	0.2	$	—	$	7.4
Federal National Mortgage Association		582.5		138.6		—		721.1
Federal Home Loan Mortgage Corporation		230.7		161.8		—		392.5
Total	$	820.4	$	300.6	$	—	$	1,121.0
December 31, 2006:
Government National Mortgage Association	$	8.1	$	1.3	$	—	$	9.4
Federal National Mortgage Association		638.9		185.2		—		824.1
Federal Home Loan Mortgage Corporation		253.7		233.8		—		487.5
Total	$	900.7	$	420.3	$	—	$	1,321.0

The following table summarizes, for all securities in an unrealized loss position as of June 30, 2007 and December 31, 2006, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position:

48

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

	June 30, 2007				December 31, 2006
(Dollars in millions)	Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses
Municipal obligations in continuous unrealized loss for:
0 – 6 months	$	2,435.7	$	48.5	$	658.5	$	3.4
7 – 12 months		234.3		5.0		69.9		0.6
Greater than 12 months		1,172.2		30.7		1,129.3		16.7
		3,842.2		84.2		1,857.7		20.7
Corporate obligations in continuous unrealized loss for:
0 – 6 months		191.9		3.7		34.6		0.1
7 – 12 months		—		—		33.2		0.2
Greater than 12 months		58.5		1.5		50.9		0.8
		250.4		5.2		118.7		1.1
Foreign obligations in continuous unrealized loss for:
0 – 6 months		75.0		1.3		78.8		0.9
7 – 12 months		25.5		0.9		26.5		0.3
Greater than 12 months		40.4		0.7		13.1		0.2
		140.9		2.9		118.4		1.4
U.S. government obligations in continuous unrealized loss for:
0 – 6 months		90.5		4.2		23.1		0.1
7 – 12 months		3.6		0.1		—		—
Greater than 12 months		35.5		1.6		128.4		3.1
		129.6		5.9		151.5		3.2
U.S. agency obligations in continuous unrealized loss for:
0 – 6 months		252.6		6.3		239.1		1.2
7 – 12 months		27.7		0.9		—		—
Greater than 12 months		209.2		6.2		234.1		5.2
		489.5		13.4		473.2		6.4
Mortgage and asset-backed securities in continuous unrealized loss for:
0 – 6 months		1,048.3		6.0		426.9		1.9
7 – 12 months		87.2		3.3		75.5		0.6
Greater than 12 months		900.4		26.6		1,177.4		24.5
		2,035.9		35.9		1,679.8		27.0
Other in continuous unrealized loss for:
0 – 6 months		—		—		0.3		—
7 – 12 months		0.1		—		0.2		—
Greater than 12 months		—		—		—		—
		0.1		—		0.5		—
Total	$	6,888.6	$	147.5	$	4,399.8	$	59.8

49

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Management has determined that the unrealized losses in fixed income securities at June 30, 2007 are primarily attributable to the current interest rate environment and that these unrealized losses are temporary in nature based upon (i) no principal and interest payment defaults on these securities; (ii) analysis of the creditworthiness of the issuers; and (iii) Ambac’s ability and current intent to hold these securities until a recovery in fair value or maturity. Of the $6,888.6 million that were in a gross unrealized loss position at June 30, 2007, below investment grade securities and non-rated securities had a fair value of $0.1 million and an unrealized loss of less than $0.01 million. Of the $4,399.8 million that were in a gross unrealized loss position at December 31, 2006, below investment grade securities and non-rated securities had a fair value of $0.5 million and an unrealized loss of less than $0.1 million.

There were no impairment write-downs during the three and six months ended June 30, 2007 and $0.1 million during the three and six months ended June 30, 2006. The net realized investment gains were primarily the result of the NCFE impairment recoveries received in the six months ended June 30, 2007 and 2006. Other net realized investment gains and losses in the six months ended June 30, 2007 and 2006 were the result of security sales made in the ordinary course of business in order to achieve Ambac’s investment objectives for the Financial Guarantee and Financial Services investment portfolios.

The following table provides the ratings distribution of the fixed income investment portfolio at June 30, 2007 and December 31, 2006 by segment:

Rating (1) : June 30, 2007:	Financial Guarantee		Financial Services		Combined
AAA	87	%	91	%	89	%
AA	11		3		8
A	1		5		3
BBB	<1		1		<1
Below investment grade	<1		<1		<1
Not Rated	<1		—		<1
	100	%	100	%	100	%
December 31, 2006:
AAA	87	%	91	%	89	%
AA	11		3		8
A	1		5		3
BBB	<1		1		<1
Below investment grade	—		<1		<1
Not Rated	<1		—		<1
	100	%	100	%	100	%

(1) Ratings represent Standard & Poor’s classifications. If unavailable, Moody’s rating is used.

Ambac’s fixed income portfolio includes securities covered by guarantees issued by Ambac Assurance (“insured securities”). The published ratings on these securities are triple-A by the major rating agencies as a result of the Ambac Assurance insurance policy and are reflected in the above table as AAA. Rating agencies generally do not publish separate underlying ratings (those ratings excluding the Ambac Assurance insurance) because the insurance cannot be legally separated from the underlying security by the insurer. Ambac obtains underlying ratings through ongoing dialog with rating agencies. In the event these

50

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

underlying ratings are not available from the rating agencies, Ambac will assign an internal rating. At June 30, 2007, securities with a total carrying value of $704.4 million representing 4% of the investment portfolio with a weighted-average underlying rating of BBB- was insured by Ambac. In determining this BBB- rating, approximately $131.7 million of the securities were assigned internal ratings by Ambac.

Special Purpose and Variable Interest Entities. Information regarding special purpose and variable interest entities can be found in the Notes to the Unaudited Consolidated Financial Statements of this Form 10-Q.

Cash Flows. Net cash provided by operating activities was $444.2 million and $552.5 million during the six months ended June 30, 2007 and 2006, respectively. These cash flows were primarily provided by Financial Guarantee operations. The decrease in cash provided by operating activities is primarily due to the proceeds from the 2006 sale of three aircraft, lower net insurance premium receipts in 2007 and purchases of trading account assets, partially offset by net claim recoveries in 2007. Future net cash provided by operating activities will be impacted by the level of premium collections and claim payments.

Net cash provided by financing activities was $495.9 million and $407.4 million during the six months ended June 30, 2007 and 2006, respectively. Financing activities for the six months ended June 30, 2007 included $182.7 million in net investment and payment agreements issued (net of investment and payment agreement draws paid) and the proceeds of the issuance of DISCs of $393.3 million, partially offset by purchases of treasury shares of $428.9 million. Financing activities for the six months ended June 30, 2006 included $428.5 million in net investment and payment agreements issued (net of investment and payment agreements draws paid) and purchases of treasury shares of $43.8 million.

Net cash used in investing activities was $936.2 million during the six months ended June 30, 2007, of which $1,861.1 million and $235.9 million, was used to purchase bonds and loans, respectively, partially offset by proceeds from sales and maturities of bonds of $1,135.0 million. For the six months ended June 30, 2006, $956.0 million was used in investing activities, of which $3,313.0 million was used to purchase bonds, partially offset by the proceeds and maturities of bonds of $1,816.0 million.

Net cash provided by operating, investing and financing activities was $3.9 million and $3.9 million during the six months ended June 30, 2007 and 2006, respectively.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

In the ordinary course of business, Ambac manages a variety of risks, principally credit, market, liquidity, operational and legal. These risks are identified, measured and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization.

51

Item 3. Quantitative and Qualitative Disclosures About Market Risk (Continued)

Credit Risk. Ambac is exposed to credit risk in various capacities including as an issuer of financial guarantees, as counterparty to reinsurers and derivative and other financial contracts and as a holder of investment securities. Ambac’s Portfolio Risk Management Committee (“PRMC”) employs various procedures and controls to monitor and manage credit risk. The PRMC is comprised of senior risk professionals and senior management of Ambac. Its purview is enterprise-wide and its focus is on risk limits and measurement, concentration and correlation of risk, and the attribution of economic and regulatory capital in a portfolio context.

All financial guarantees and credit derivatives issued are subject to a formal credit underwriting process. Various factors affecting the creditworthiness of the underlying obligation are evaluated during the underwriting process. Senior credit personnel approve all transactions prior to issuing a financial guarantee. Subsequent to the issuance of a financial guarantee, credit personnel perform periodic reviews of exposures according to a schedule based on the risk profile of the guaranteed obligations or as necessitated by specific credit events or other macro-economic variables. Proactive credit remediation can help secure rights and remedies which mitigate losses in the event of default.

Ambac manages credit risk associated with its investment portfolio through adherence to specific investment guidelines. These guidelines establish limits based upon single risk concentration and minimum credit rating standards. Additionally, senior credit personnel monitor the portfolio on a continuous basis. Credit risk relating to derivative positions (other than credit derivatives) primarily concern counterparty default. The majority of these counterparties are clients of the financial guarantee business which have been subject to our formal underwriting process upon the issuance of a financial guarantee. The counterparty creditworthiness of new clients is separately evaluated by senior credit personnel upon entering these contracts. Counterparty default exposure is mitigated through the use of industry standard collateral posting agreements. For counterparties subject to such collateral posting agreements, collateral is posted when a derivative counterparty’s credit exposure exceeds contractual limits.

To minimize exposure to significant losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of a rating downgrade of a reinsurer. Ambac Assurance held letters of credit and collateral amounting to approximately $370.0 million from its reinsurers as of June 30, 2007. The rating agencies continually review reinsurers providing coverage to the financial guarantee industry. The following table provides ceded par outstanding by financial strength rating of Ambac Assurance’s reinsurers, on a Standard and Poor’s (“S&P”) basis:

(Dollars in billions)	June 30, 2007		December 31, 2006
AAA	$	20.6	$	20.7
AA		30.8		27.7
Total	$	51.4	$	48.4

Market Risk. Market risk represents the potential for losses that may result from changes in the value of a financial instrument as a result of changes in market conditions. The primary market risks that would impact the value of Ambac’s financial instruments are interest rate risk, basis risk (e.g., taxable interest rates relative to tax-exempt interest rates, discussed

52

Item 3. Quantitative and Qualitative Disclosures About Market Risk (Continued)

below) and credit spread risk. Below we discuss each of these risks and the specific types of financial instruments impacted. Senior managers in Ambac’s Risk Analysis and Reporting group are responsible for monitoring risk limits and applying risk measurement methodologies. The results of this effort are reported to the PRMC. The estimation of potential losses arising from adverse changes in market conditions is a key element in managing market risk. Ambac utilizes various systems, models and stress test scenarios to monitor and manage market risk. This process includes frequent analyses of both parallel and non-parallel shifts in the yield curve, “Value-at-Risk” (“VaR”) and changes in credit spreads. These models include estimates, made by management, which utilize current and historical market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market.

Financial instruments that may be adversely affected by changes in interest rates consist primarily of investment securities, loans, investment agreement liabilities, obligations under payment agreements, long-term debt, and interest rate derivative contracts.

Ambac, through its subsidiary Ambac Financial Services, is a provider of interest rate swaps to states, municipalities and their authorities and other entities in connection with their financings. Ambac Financial Services manages its municipal interest rate swaps business with the goal of being market neutral to changes in overall rates while retaining some basis risk. Ambac’s municipal interest rate swap portfolio may be adversely affected by changes in basis. If actual or projected tax-exempt interest rates increase in a parallel shift by 1% in relation to taxable interest rates, Ambac will experience a market-to-market loss of $0.19 million and $0.04 million at June 30, 2007 and December 31, 2006, respectively.

A portion of the municipal interest rate swaps transacted by Ambac Financial Services contain provisions that are designed to protect Ambac against certain forms of tax reform, thus mitigating its basis risk. The estimation of potential losses arising from adverse changes in market relationships, known as VaR, is a key element in management’s monitoring of basis risk for the municipal interest rate swap portfolio. Ambac has developed a VaR methodology to estimate potential losses using a one day time horizon and a 99% confidence level. This means that Ambac would expect to incur losses greater than that predicted by VaR estimates only once in every 100 trading days, or about 2.5 times a year. Ambac’s methodology estimates VaR using a 300-day historical “look back” period. This means that changes in market values are simulated using market inputs from the past 300 days. Ambac supplements its VaR methodology, which is a good risk management tool in normal markets, by performing rigorous stress testing to measure the potential for losses in abnormally volatile markets. These stress tests include (i) parallel and non-parallel shifts in the yield curve and (ii) immediate changes in normal basis relationships, such as those between taxable and tax-exempt markets.

Financial instruments that may be adversely affected by changes in credit spreads include Ambac’s outstanding credit derivative and total return contracts. Ambac, through its subsidiary Ambac Credit Products, enters into credit derivative contracts. These contracts require Ambac Credit Products to make payments upon the occurrence of certain defined credit events relating to an underlying obligation (generally a fixed income obligation). If credit spreads of the underlying obligations change, the fair value of the related credit derivative changes. Market liquidity could also impact valuations of the underlying obligations. As such, Ambac Credit Products could experience mark-to-market gains or losses. Changes in credit spreads are generally caused by changes in the market’s perception of the credit quality of the underlying obligations. Ambac offers credit derivatives to provide credit protection enabling financial institutions to hedge portfolios of credit risk achieving either economic or regulatory relief.

53

Item 3. Quantitative and Qualitative Disclosures About Market Risk (Continued)

Ambac Credit Products structures its contracts with first loss or other financial protection. Such structuring mitigates Ambac Credit Products’ risk of loss and generally reduces the mark-to-market volatility of these credit derivatives.

Ambac, through its subsidiary Ambac Capital Services, enters into total return swap contracts. These contracts require Ambac Capital Services to pay a specified spread in excess of LIBOR in exchange for receiving the total return of an underlying fixed income obligation over a specified period of time. If credit spreads of the underlying obligations change, the market value of the related total return swaps changes and Ambac Capital Services could experience mark-to-market gains or losses.

The following table summarizes the estimated change in fair values on the net balance of Ambac’s net structured credit and total return swap derivative positions assuming immediate parallel shifts in credit spreads at June 30, 2007:

(Dollars in millions) Change in Credit Spreads	Estimated Net Fair			Estimated Gain/(Loss)
June 30, 2007:
50 basis point widening	$	(636	)	$	(596	)
25 basis point widening		(338	)		(298	)
10 basis point widening		(160	)		(120	)
Base scenario		(40	)		—
10 basis point narrowing		77			117
25 basis point narrowing		203			243
50 basis point narrowing		231			271

The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates, and other market conditions at the time these fair values are determined. In addition, since each transaction has unique collateral and structure terms, the underlying change in fair value of each transaction may vary considerably. During the second quarter of 2007, Ambac incurred net mark-to-market losses on credit derivative contracts of $56.9 million related primarily to credit derivatives on CDOs of ABS containing sub-prime RMBS exposure. During the second quarter of 2007, credit spreads on these underlying CDO of ABS obligations widened by approximately 16 basis points. This credit spread widening and resulting negative mark-to-market is driven by current market concerns over the most recent vintages of sub-prime RMBS and the recent lack of liquidity in the CDO of ABS market. So far in the third quarter of 2007, credit spreads have continued to widen, particularly on CDO of ABS and collateralized loan obligations where Ambac has outstanding credit derivatives.

Liquidity Risk. Liquidity risk relates to the possible inability to satisfy contractual obligations when due. This risk is present in financial guarantee contracts, derivative contracts and investment agreements. Ambac Assurance manages its liquidity risk by maintaining a comprehensive analysis of projected cash flows. Additionally, the financial guarantee business maintains a minimum level of cash and short-term investments at all times. The investment agreement business manages liquidity risk by closely matching the maturity schedules of its invested assets, including hedges, with the maturity schedules of its investment agreement liabilities. Ambac Financial Services maintains cash and short-term investments and closely matches the dates swap payments are made and received. See additional discussion in “Liquidity and Capital Resources” section.

54

Item 3. Quantitative and Qualitative Disclosures About Market Risk (Continued)

Operational Risk. Operational risk relates to the potential for loss caused by a breakdown in information, communication and settlement systems. Ambac mitigates operational risk by maintaining and testing critical systems (and their system backup) and performing ongoing control procedures to monitor transactions and positions, maintain documentation, confirm transactions and ensure compliance with regulations.

Ambac maintains a disaster recovery site in upstate New York as part of its Disaster Recovery Plan. This remote hot-site facility is complete with user work stations, phone system, data center, internet connectivity and a power generator, capable of serving the needs of the disaster recovery team to support all business segment operations. The plan, facility and systems are revised and upgraded where necessary, and user tested annually to confirm their readiness.

Legal Risk. Legal risks attendant to Ambac’s businesses include uncertainty with respect to the enforceability of the obligations insured by Ambac Assurance and the security for such obligations, as well as uncertainty with respect to the enforceability of the obligations of Ambac’s counterparties, including contractual provisions intended to reduce exposure by providing for the offsetting or netting of mutual obligations. Ambac seeks to remove or minimize such uncertainties through continuous consultation with internal and external legal advisers to analyze and understand the nature of legal risk, to improve documentation and to strengthen transaction structure.

55

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures. Ambac Financial Group’s management, with the participation of Ambac Financial Group’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Ambac Financial Group’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, Ambac Financial Group’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Ambac Financial Group’s disclosure controls and procedures are effective at the reasonable assurance level in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Ambac Financial Group (including its consolidated subsidiaries) in the reports that it files or submits under the Exchange Act.

(b) Changes in Internal Controls Over Financial Reporting. There have not been any changes in Ambac Financial Group’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during Ambac Financial Group’s fiscal quarter ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, Ambac Financial Group’s internal control over financial reporting.

56

PART II - OTHER INFORMATION

Items 1, 3, and 5 are omitted either because they are inapplicable or because the answer to such question is negative.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

The Board of Directors of Ambac, has authorized the establishment of a stock repurchase program that permits the repurchase of up to 24,000,000 shares of Ambac’s Common Stock. Ambac will only repurchase shares of its Common Stock under the repurchase program where it feels that it is economically attractive to do so and is in conformity with regulatory and rating agency guidelines. The following table summarizes Ambac’s repurchase program during the second quarter of 2007 and shares available at June 30, 2007:

	Total Shares Purchased (1)	Average Price Paid Per Share (2)		Total Number of Shares Purchased as Part of Publicly Announced Plan (1)	Maximum Number of Shares That May Yet Be Purchased Under the Plan
April 2007	—	$	—	—	4,600,141
May 2007	1,572	$	93.12	1,572	4,598,569
June 2007	398,223	$	42.53	398,223	4,200,346
Second quarter 2007	399,795	$	42.73	399,795	4,200,346

(1) All shares repurchased were pursuant to a stock repurchase program authorized by Ambac’s Board of Directors, for settling awards under Ambac’s long-term incentive plans.

(2) The average price per share for June and the second quarter of 2007 was impacted by the receipt of 203,506 shares under the accelerated share buyback program. The cost of these shares were included in the first quarter of 2007.

On February 12, 2007, Ambac issued $400 million of Directly-Issued Subordinated Capital Securities (“DISCS”). Ambac used the net proceeds from the offering and additional funds to purchase $400 million worth of shares of its common stock through an accelerated share repurchase program. Common stock purchased through the accelerated share repurchase program resulted in 4,459,223 shares being acquired during the six months ended June 30, 2007.

From July 1, 2007 through August 2, 2007, Ambac has repurchased 250,000 shares of its Common Stock under its stock repurchase program.

57

PART II - OTHER INFORMATION (Continued)

Item 4 – Submission of Matters to a Vote of Security Holders

The following matters were voted upon at the Annual Meeting of Stockholders of Ambac held on May 8, 2007, and received the votes set forth below:

Proposal 1. The following directors were elected to serve on Ambac’s Board of Directors:

	Number of Votes Cast
	For	Withheld
Michael A. Callen	87,040,506	3,583,729
Jill M. Considine	87,147,166	3,477,069
Philip N. Duff	87,363,775	3,260,460
Robert J. Genader	87,102,533	3,521,702
W. Grant Gregory	87,119,762	3,504,473
Thomas C. Theobald	87,602,913	3,021,322
Laura S. Unger	87,753,397	2,870,838
Henry D. G. Wallace	87,751,972	2,872,263

There were no broker non-votes for this proposal.

Proposal 2. The proposal to ratify the selection of KPMG LLP, an independent registered public accounting firm, as auditors of Ambac and its subsidiaries for 2007 was adopted, with 88,838,478 votes in favor, 1,285,944 votes against and 500,119 votes abstaining. There were no broker non-votes for this proposal.

58

PART II - OTHER INFORMATION (Continued)

Item 6 - Exhibits

The following are annexed as exhibits:

Exhibit Number	Description
3.05	By-laws of Ambac Financial Group, Inc., as amended through May 8, 2007.
10.41	Ambac Financial Group, Inc. 1997 Equity Plan, as amended through July 24, 2006.
10.42	Ambac Financial group, Inc. 1997 Non-Employee Directors Equity Plan, as amended through January 30, 2007.
10.43	Ambac Financial Group, Inc. 1997 Executive Incentive Plan, as amended through January 30, 2007.
10.44	Ambac Financial Group, Inc. Deferred Compensation Plan for Outside Directors, effective as of December 1, 1993, as amended through December 4, 2006.
31.1	Certification of CEO Pursuant to Exchange Act Rules 13a-14 and 15d-14.
31.2	Certification of CFO Pursuant to Exchange Act Rules 13a-14 and 15d-14.
32.1	Certification of CEO Pursuant to 18 U.S.C. Section 1350.
32.2	Certification of CFO Pursuant to 18 U.S.C. Section 1350.
99.05	Ambac Assurance Corporation and Subsidiaries Consolidated Unaudited Financial Statements as of June 30, 2007 and December 31, 2006 and for the periods ended June 30, 2007 and 2006.

59

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

	Ambac Financial Group, Inc. (Registrant)
Dated: August 9, 2007	By:	/s/ Sean T. Leonard
		Sean T. Leonard
		Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Officer)

60

INDEX TO EXHIBITS

Exhibit Number	Description
3.05	By-laws of Ambac Financial Group, Inc., as amended through May 8, 2007.
10.41	Ambac Financial Group, Inc. 1997 Equity Plan, as amended through July 24, 2006.
10.42	Ambac Financial group, Inc. 1997 Non-Employee Directors Equity Plan, as amended through January 30, 2007.
10.43	Ambac Financial Group, Inc. 1997 Executive Incentive Plan, as amended through January 30, 2007.
10.44	Ambac Financial Group, Inc. Deferred Compensation Plan for Outside Directors, effective as of December 1, 1993, as amended through December 4, 2006.
31.1	Certification of CEO Pursuant to Exchange Act Rules 13A-14 and 15D-14, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of CFO Pursuant to Exchange Act Rules 13A-14 and 15D-14, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.05	Ambac Assurance Corporation and Subsidiaries Consolidated Unaudited Financial Statements as of June 30, 2007 and December 31, 2006 and for the periods ended June 30, 2007 and 2006.

61

EX-3.05

EXHIBIT 3.05

BY-LAWS

OF

AMBAC FINANCIAL GROUP, INC.

Amended through

May 8, 2007

TABLE OF CONTENTS

		Page
	ARTICLE I
	OFFICES
SECTION 1.01	Registered Office	1
SECTION 1.02	Other Offices	1
	ARTICLE II
	MEETINGS OF STOCKHOLDERS
SECTION 2.01	Annual Meetings	1
SECTION 2.02	Special Meetings	1
SECTION 2.03	Notice of Meetings	1
SECTION 2.04	Waiver of Notice	2
SECTION 2.05	Adjournments	2
SECTION 2.06	Quorum	2
SECTION 2.07	Voting	3
SECTION 2.08	Proxies	3
SECTION 2.09	Chairman and Secretary at Meetings	3
SECTION 2.10	Inspectors of Election	3
SECTION 2.11	List of Stockholders	4
SECTION 2.12	Notice of Stockholder Business	4
SECTION 2.13	Notice of Stockholder Nominees	5
SECTION 2.14	Stockholders’ Consent in Lieu of Meeting	5
	ARTICLE III
	BOARD OF DIRECTORS
SECTION 3.01	General Powers	6
SECTION 3.02	Number and Term of Office	7
SECTION 3.03	Resignation	7
SECTION 3.04	Removal	7
SECTION 3.05	Vacancies	7
SECTION 3.06	The Chairman
SECTION 3.07	Meetings	7
SECTION 3.08	Committees of the Board	9
SECTION 3.09	Directors’ Consent in Lieu of Meeting	9
SECTION 3.10	Action by Means of Telephone or Similar Communications Equipment	9
SECTION 3.11	Compensation	9

i

		Page
	ARTICLE IV
	OFFICERS
SECTION 4.01	Officers	10
SECTION 4.02	Authority and Duties	10
SECTION 4.03	Term of Office, Resignation and Removal	10
SECTION 4.04	Vacancies	10
SECTION 4.05	The Chief Executive Officer	11
SECTION 4.06	The President	11
SECTION 4.07	Vice Chairmen, Vice Presidents and Managing Directors	11
SECTION 4.08	The Secretary	11
SECTION 4.09	Assistant Secretaries	12
SECTION 4.10	The Treasurer	12
SECTION 4.11	Assistant Treasurers	12
	ARTICLE V
	CHECKS, DRAFTS, NOTES AND PROXIES
SECTION 5.01	Checks, Drafts and Notes	12
SECTION 5.02	Execution of Proxies	12
	ARTICLE VI
	SHARES AND TRANSFERS OF SHARES
SECTION 6.01	Certificates Evidencing Shares	13
SECTION 6.02	Transfers of Shares	13
SECTION 6.03	Holder of Record	13
SECTION 6.04	Addresses of Stockholders	13
SECTION 6.05	Lost, Destroyed and Mutilated Certificates	14
SECTION 6.06	Regulations	14
SECTION 6.07	Fixing Date for Determination of Stockholders of Record	14
	ARTICLE VII
	SEAL
SECTION 7.01	Seal	14
	ARTICLE VIII
	FISCAL YEAR
SECTION 8.01	Fiscal Year	15

ii

		Page
	ARTICLE IX
	INDEMNIFICATION AND INSURANCE
SECTION 9.01	Indemnification	15
SECTION 9.02	Insurance for Indemnification	17
	ARTICLE X
	AMENDMENTS
SECTION 10.01	Amendments	17

iii

By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

BY-LAWS

OF

AMBAC FINANCIAL GROUP, INC.

(Amended through May 8, 2007)

ARTICLE I

OFFICES

SECTION 1.01 Registered Office. The registered office of Ambac Financial Group, Inc. (the “Corporation”) in the State of Delaware shall be at the principal office of The Corporation Trust Company in the City of Wilmington, County of New Castle, and the registered agent in charge thereof shall be The Corporation Trust Company.

SECTION 1.02 Other Offices. The Corporation may also have an office or offices at any other place or places within or without the State of Delaware as the Board of Directors of the Corporation (the “Board”) may from time to time determine or the business of the Corporation may from time to time require.

ARTICLE II

MEETINGS OF STOCKHOLDERS

SECTION 2.01 Annual Meetings. The annual meeting of Stockholders (as defined in Section 2.03) of the Corporation for the election of directors of the Corporation (“Directors”), and for the transaction of such other business as may properly come before such meeting, shall be held at such place, date and time as shall be fixed by the Board and designated in the notice or waiver of notice of such annual meeting.

SECTION 2.02 Special Meetings. Special meetings of Stockholders for any purpose or purposes may be called by the Board or the Chairman of the Board of the Corporation (the “Chairman”), the President of the Corporation (the “President”) or the Secretary of the Corporation (the “Secretary”), to be held at such place, date and time as shall be designated in the notice or waiver of notice thereof. Business transacted at all special meetings shall be confined to the objects stated in the notice of special meeting.

- 1 -

By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

SECTION 2.03 Notice of Meetings. (a) Except as otherwise provided by law, written notice of each annual or special meeting of Stockholders stating the place, date and time of such meeting and, in the case of a special meeting, the purpose or purposes for which such meeting is to be held, shall be given to each recordholder of shares of common stock of the Corporation issued and outstanding (“Shares”) entitled to vote thereat, not less than 10 nor more than 90 days before the date of such meeting. If mailed, such notice shall be deemed to be given when deposited in the United States mail, postage prepaid, directed to the recordholder of Shares (a “Stockholder”) at such Stockholder’s address as it appears on the records of the Corporation.

(b) Notice of a special meeting of Stockholders may be given by the person or persons calling the meeting, or, upon the written request of such person or persons, such notice shall be given by the Secretary on behalf of such person or persons. If the person or persons calling a special meeting of Stockholders give notice thereof, such person or persons shall deliver a copy of such notice to the Secretary. Each request to the Secretary for the giving of notice of a special meeting of Stockholders shall state the purpose or purposes of such meeting.

SECTION 2.04 Waiver of Notice. Notice of any annual or special meeting of Stockholders need not be given to any Stockholder who files a written waiver of notice with the Secretary, signed by the person entitled to notice whether before or after such meeting. Neither the business to be transacted at, nor the purpose of, any meeting of Stockholders need to be specified in any written waiver of notice thereof. Attendance of a Stockholder at a meeting, in person or by proxy, shall constitute a waiver of notice of such meeting, except when such Stockholder attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business on the grounds that the notice of such meeting was inadequate or improperly given.

SECTION 2.05 Adjournments. Whenever a meeting of Stockholders, annual or special, is adjourned to another date, time or place, notice need not be given of the adjourned meeting if the date, time and place thereof are announced at the meeting at which the adjournment is taken. If the adjournment is for more than 30 days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each Stockholder entitled to vote thereat. At the adjourned meeting, any business may be transacted which might have been transacted at the

- 2 -

By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

original meeting. Any previously scheduled meeting of the Stockholders may be postponed, and (unless the Certificate of Incorporation of the Corporation (the “Certificate of Incorporation”) otherwise provides) any special meeting of the Stockholders may be canceled, by resolution of the Board upon public notice given prior to the date previously scheduled for such meeting of Stockholders.

SECTION 2.06 Quorum. Except as otherwise provided by law or the Certificate of Incorporation, the recordholders of a majority of the Shares entitled to vote thereat, present in person or by proxy, shall constitute a quorum for the transaction of business at all meetings of Stockholders, whether annual or special. If, however, such quorum shall not be present in person or by proxy at any meeting of Stockholders, the presiding officer at the meeting of the Stockholders entitled to vote thereat may adjourn the meeting from time to time in accordance with Section 2.05 hereof until a quorum shall be present in person or by proxy.

SECTION 2.07 Voting. Each Stockholder shall be entitled to one vote for each Share held of record by such Stockholder. Except as otherwise provided by law or the Certificate of Incorporation, when a quorum is present at any meeting of Stockholders, the vote of the recordholders of a majority of the Shares constituting such quorum shall decide any question brought before such meeting.

SECTION 2.08 Proxies. Each Stockholder entitled to vote at a meeting of Stockholders or to express, in writing, consent to or dissent from any action of Stockholders without a meeting may authorize another person or persons to act for such Stockholder by proxy. Such authorization must be in writing and executed by the Stockholder or his or her authorized officer, director, employee or agent. No proxy shall be voted or acted upon more than three years from its date, unless the proxy provides for a longer period. Each proxy shall be delivered to the inspectors of election prior to or at the meeting. A duly executed proxy shall be irrevocable if it states that it is irrevocable and if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power. A Stockholder may revoke any proxy which is not irrevocable by attending the meeting and voting in person or by filing an instrument in writing revoking the proxy or by filing a subsequent duly executed proxy with the Secretary of the Corporation. Unless a greater number of affirmative votes is required by the Certificate of Incorporation, these by-laws, the rules or regulations of any stock exchange applicable to the

- 3 -

By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

Corporation, or as otherwise required by law or pursuant to any regulation applicable to the Corporation, if a quorum exists at any meeting of Stockholders, Stockholders shall have approved any matter, other than the election of directors, if the votes cast by Stockholders present in person or represented by proxy at the meeting and entitled to vote on the matter in favor of such matter exceed the votes cast by such Stockholders against such matter. Directors shall be elected by a plurality of the votes cast.

SECTION 2.09 Chairman and Secretary at Meetings. At any meeting of Stockholders, the Chairman, or in his absence, the President, or if neither such person is available, then a person designated by the Board, shall preside at and act as chairman of the meeting. The Secretary, or in his absence a person designated by the chairman of the meeting, shall act as secretary of the meeting.

SECTION 2.10 Inspectors of Election. The votes at each meeting of Stockholders shall be supervised by not less than two inspectors of election who shall decide all questions respecting the qualification of voters, the validity of the proxies and the acceptance or rejection of votes. The Board shall, in advance of any meeting of Stockholders, appoint two or more inspectors of election to act at the meeting and make a written report thereof. The Board may designate one or more persons as alternate inspectors to replace any inspector who fails to act. In the event that there are less than two inspectors present and acting at any meeting, the chairman of the meeting shall appoint an additional inspector or inspectors so that there shall always be at least two inspectors to act at the meeting. Each inspector, before entering upon the discharge of this or her duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his or her ability.

SECTION 2.11 List of Stockholders. A complete list of the Stockholders entitled to vote at each meeting of Stockholders, arranged in alphabetical order, and showing the address and number of shares registered in the name of each Stockholder, shall be prepared and made available for examination during regular business hours by any Stockholder for any purpose germane to the meeting. The list shall be available for such examination for a period of not less than ten days prior to the meeting and during the whole time of the meeting either at a place within the city where the meeting is to be held, which place shall be specified in the notice of meeting or, if not so specified, at the place where the meeting is to be held.

- 4 -

By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

SECTION 2.12 Notice of Stockholder Business. At an annual meeting of the Stockholders, only such business shall be conducted as shall have been brought before the meeting (a) by or at the direction of the Board or (b) by any Stockholder who complies with the notice procedures set forth in this Section 2.12. For business to be properly brought before an annual meeting by a Stockholder, the Stockholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a Stockholder’s notice must be delivered to or mailed and received at the principal executive offices of the Corporation, not less than sixty days nor more than ninety days prior to the meeting; provided, however, that in the event that less than seventy days’ notice or prior public disclosure of the date of the meeting is given or made to the Stockholders, notice by the Stockholder to be timely must be received not later than the close of business on the 10th day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made. A Stockholder’s notice to the Secretary shall set forth as to each matter the Stockholder proposes to bring before the annual meeting (a) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting; (b) the name and address, as they appear on the Corporation’s books, of the Stockholder proposing such business; (c) the class and number of shares of the Corporation which are beneficially owned by the Stockholder; and (d) any material interest of the Stockholder in such business. Notwithstanding anything in these By-laws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 2.12. The chairman of an annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting and in accordance with the provisions of this Section 2.12, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. Notwithstanding the foregoing provisions of this Section 2.12, a Stockholder seeking to have a proposal included in the Corporation’s proxy statement shall comply with the requirements of Regulation 14A under the Securities Exchange Act of 1934, as amended (including, but not limited to, Rule 14a-8 or its successor provision.)

SECTION 2.13 Notice of Stockholder Nominees. Only persons who are nominated in accordance with the procedures set forth in these By-laws shall be eligible for election as Directors. Nominations of persons for election to the Board may be made at a meeting of Stockholders (a) by or at the direction of the Board or (b) by any Stockholder entitled to vote for the election of Directors at the

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

meeting who complies with the notice procedures set forth in this Section 2.13. Nominations by Stockholders shall be made pursuant to timely notice in writing to the Secretary of the Corporation. To be timely, a Stockholder’s notice shall be delivered to or mailed and received at the principal executive offices of the Corporation not less than sixty days nor more than ninety days prior to the meeting; provided, however, that in the event that less than seventy days’ notice or prior public disclosure of the date of the meeting is given or made to Stockholders, notice by the Stockholder to be timely must be so received not later than the close of business on the 10th day following the day on which such notice of the date of the meeting was mailed or such public disclosure was made. Such nominations and written notice of any nominations by Stockholders under this section shall contain the following information: (a) name, residence and business address of the nominating Stockholder; (b) a representation that the Stockholder is a record holder or beneficial owner of the Corporation’s voting shares and a statement of the number of such shares; (c) a representation that the Stockholder intends to appear in person or by proxy at the meeting to nominate the individuals specified in the notice, if the nominations are to be made at a meeting of Stockholders; (d) information regarding each nominee such as would be required to be included in a proxy statement or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended; (e) a description of all arrangements or understandings between and among the Stockholder and each and every nominee; and (f) the written consent of each nominee to serve as a Director, if elected. The chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that a nomination was not made in accordance with the procedures prescribed by these By-laws, and if he should so determine, he shall so declare to the meeting and the defective nomination shall be disregarded.

SECTION 2.14 Stockholders’ Consent in Lieu of Meeting. (a) Consents to Corporate Action. Any action which is required to be or may be taken at any annual or special meeting of Stockholders, subject to the provisions of Subsections (b) and (c) of this Section 2.14, may be taken without a meeting, without prior notice and without a vote if consents in writing, setting forth the action so taken, shall have been signed by the holders of the outstanding Shares having not less than the minimum number of votes that would be necessary to authorize or to take such action at a meeting at which all Shares entitled to vote thereon were present and voted; provided, however, that prompt notice of the taking of the corporate action without a meeting and by less than unanimous written consent shall be given to those Stockholders who have not consented in writing.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

(b) Determination of Record Date of Action by Written Consent. The record date for determining Stockholders entitled to express consent to corporate action in writing without a meeting shall be fixed by the Board. Any Stockholder of record seeking to have the Stockholders authorize or take corporate action by written consent without a meeting shall, by written notice to the Secretary, request the Board to fix a record date. Upon receipt of such a request, the Secretary shall place such request before the Board at its next regularly scheduled meeting, provided, however, that if the Stockholder represents in such request that he intends, and is prepared, to commence a consent solicitation as soon as is permitted by the Securities Exchange Act of 1934, as amended, and the regulations thereunder and other applicable law, the Secretary shall, as promptly as practicable, call a special meeting of the Board, which meeting shall be held as promptly as practicable. At such regular or special meeting, the Board shall fix a record date as provided in Section 213(a) (or its successor provision) of the General Corporation Law of the State of Delaware (the “General Corporation Law”). Should the Board fail to fix a record date as provided for in this Subsection (b), then the record date shall be the day on which the first written consent is expressed.

(c) Procedures for Written Consent. In the event of the delivery to the Corporation of a written consent or consents purporting to represent the requisite voting power to authorize or take corporate action and/or related revocations, the Secretary shall provide for safekeeping of such consents and revocations and shall, as promptly as practicable, engage nationally recognized independent judges of election for the purpose of promptly performing a ministerial review of the validity of the consents and revocations. No action by written consent and without a meeting shall be effective until such judges have completed their review, determined that the requisite number of valid and unrevoked consents has been obtained to authorize or take action specified in the consents, and certified such determination for entry in the records of the Corporation kept for the purpose of recording the proceedings of meetings of Stockholders.

ARTICLE III

BOARD OF DIRECTORS

SECTION 3.01 General Powers. The business and affairs of the Corporation shall be managed by the Board, which may exercise all

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

such powers of the Corporation and do all such lawful acts and things as are not by law, the Certificate of Incorporation or these By-laws directed or required to be exercised or done by Stockholders.

SECTION 3.02 Number and Term of Office. The number of Directors shall be three or such greater number as shall be fixed from time to time by the Board. Directors need not be Stockholders. Directors shall be elected at the annual meeting of Stockholders, and each Director shall hold office until his successor is elected and qualified, or until his earlier death or resignation or removal in the manner hereinafter provided.

SECTION 3.03 Resignation. Any Director may resign at any time by giving written notice to the Board, the Chairman or the Secretary. Such resignation shall take effect at the time specified in such notice or, if the time is not specified, upon receipt thereof by the Board, the Chairman or the Secretary, as the case may be. Unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective.

SECTION 3.04 Removal. Any or all of the Directors may be removed, with or without cause, at any time by vote of the recordholders of a majority of the Shares then entitled to vote at an election of Directors, or by written consent of the recordholders of Shares pursuant to Section 2.14 hereof.

SECTION 3.05 Vacancies. Vacancies occurring on the Board as a result of the removal of Directors without cause may be filled only by vote of the recordholders of a majority of the Shares then entitled to vote at an election of Directors, or by written consent of such recordholders pursuant to Section 2.14 hereof. Vacancies occurring on the Board for any other reason, including, without limitation, vacancies occurring as a result of the creation of new directorships that increase the number of Directors, may be filled by such vote or written consent or by vote of the Board or by written consent of the Directors pursuant to Section 3.09 hereof. If the number of Directors then in office is less than quorum, such other vacancies may be filled by vote of a majority of the Directors then in office or by written consent of all such Directors pursuant to Section 3.09 hereof. Unless earlier removed pursuant to Section 3.04 hereof, each Director chosen in accordance with this Section 3.05 shall hold office until the next annual election of Directors by the Stockholders and until his successor shall be elected and qualified.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

SECTION 3.06 The Chairman. The Chairman shall be appointed by a majority of the directors of the Board of Directors. The Chairman shall have the power to call special meetings of Stockholders, to call special meetings of the Board and, if present, to preside at all meetings of Stockholders and all meetings of the Board. The Chairman shall perform all duties incident to the office of Chairman and all such other duties as may from time to time be assigned to him by the Board or these By-laws.

SECTION 3.07 Meetings. (a) Annual Meetings. As soon as practicable after each annual election of Directors by the Stockholders, the Board shall meet for the purpose of organization and the transaction of other business, unless it shall have transacted all such business by written consent pursuant to Section 3.09 hereof.

(b) Stated Meetings. The Board may provide for stated meetings of the Board.

(c) Other Meetings. Other meetings of the Board shall be held at such times as the Chairman, the President, the Secretary or a majority of the Board shall from time to time determine.

(d) Notice of Meetings. No notice need be given of any organization or stated meeting of the Board for which the date, hour and place have been fixed by the Board. The Secretary shall give written notice to each Director of each other organization and stated meeting and of all special meetings of the Board, which notice shall state the place, date, time and purpose of such meeting. Notice of each such meeting shall be given to each Director, if by mail, addressed to him at his residence or usual place of business, at least two days before the day on which such meeting is to be held, or shall be sent to him at such place by telecopy, telegraph, cable, or other form of recorded communication, or be delivered personally or by telephone not later than the day before the day on which such meeting is to be held. A written waiver of notice, signed by the Director entitled to notice, whether before or after the time of the meeting referred to in such waiver, shall be deemed equivalent to notice. Neither the business to be transacted at, nor the purpose of any meeting of the Board need be specified in any written waiver of notice thereof. Attendance of a Director at a meeting of the Board shall constitute a waiver of notice of such meeting, except as provided by law.

(e) Place of Meetings. The Board may hold its meetings at such place or places within or without the State of Delaware as the Board or the Chairman may from time to time determine, or as shall be designated in the respective notices or waivers of notice of such meetings.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

(f) Quorum and Manner of Acting. One-third of the total number of Directors then in office (but in no event less than three Directors) shall be present in person at any meeting of the Board in order to constitute a quorum for the transaction of business at such meeting, and the vote of a majority of those Directors present at any such meeting at which a quorum is present shall be necessary for the passage of any resolution or act of the Board, except as otherwise expressly required by law, the Certificate of Incorporation or these By-laws. In the absence of a quorum for any such meeting, a majority of the Directors present thereat may adjourn such meeting from time to time until a quorum shall be present.

(g) Organization. At each meeting of the Board, one of the following shall act as chairman of the meeting and preside, in the following order of precedence:

(i) the Chairman;

(ii) the President;

(iii) any Director chosen by a majority of the Directors present.

The Secretary or, in the case of his absence, any person (who shall be an Assistant Secretary, if an Assistant Secretary is present) whom the chairman of the meeting shall appoint shall act as secretary of such meeting and keep the minutes thereof.

SECTION 3.08 Committees of the Board. The Board may designate one or more committees, each committee to consist of one or more Directors. The Board may designate one or more Directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of such committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another Director to act at the meeting in the place of any such absent or disqualified member. A majority of the members of any committee of the Board shall be present in person at any meeting of the committee in order to constitute a quorum for the transaction of business at such meeting, and the act of a majority of the members present at any such meeting at which a quorum is present shall be the act of the committee.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

In the absence of a quorum for any such meeting, a majority of the members present thereat may adjourn such meeting from time to time until a quorum shall be present. Any committee of the Board, to the extent provided in the resolution of the Board designating such committee, shall have and may exercise all the powers and authority of the Board in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; provided, however, that no such committee shall have such power or authority in reference to the following matters: (i) approving or adopting, or recommending to the stockholders, any action or matter expressly required by the General Corporation Law to be submitted to stockholders for approval or (ii) adopting, amending or repealing these By-laws. In addition, each committee of the Board so appointed may appoint a sub-committee of the Board in furtherance of the duties delegated to it by the Board. Each committee of the Board shall keep regular minutes of its proceedings and report the same to the Board when so requested by the Board.

SECTION 3.09 Directors’ Consent in Lieu of Meeting. Any action required or permitted to be taken at any meeting of the Board or of any committee thereof may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by all the members of the Board or such committee and such consent is filed with the minutes of the proceedings of the Board or such committee.

SECTION 3.10 Action by Means of Telephone or Similar Communications Equipment. Any one or more members of the Board, or of any committee thereof, may participate in a meeting of the Board or such committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting by such means shall constitute presence in person at such meeting.

SECTION 3.11 Compensation. Unless otherwise restricted by the Certificate of Incorporation, the Board may determine the compensation of Directors. In addition, as determined by the Board, Directors may be reimbursed by the Corporation for their expenses, if any, in the performance of their duties as Directors. No such compensation or reimbursement shall preclude any Director from serving the Corporation in any other capacity and receiving compensation therefore.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

ARTICLE IV

OFFICERS

SECTION 4.01 Officers. The officers of the Corporation shall be the President, the Secretary and a Treasurer and may include one or more of the following: Vice Chairmen, Vice Presidents, Managing Directors, Assistant Secretaries and Assistant Treasurers. Any two or more offices may be held by the same person provided that the office of President and Secretary shall not be held by the same person.

SECTION 4.02 Authority and Duties. All officers shall have such authority and perform such duties in the management of the Corporation as may be provided in these By-laws or, to the extent not so provided, by resolution of the Board.

SECTION 4.03 Term of Office, Resignation and Removal. (a) Each officer shall be appointed by the Board and shall hold office for such term as may be determined by the Board. Each officer shall hold office until his successor has been appointed and qualified or his earlier death or resignation or removal in the manner hereinafter provided. The Board may require any officer to give security for the faithful performance of his duties.

(b) Any officer may resign at any time by giving written notice to the Board, the President or the Secretary. Such resignation shall take effect at the time specified in such notice or, if the time be not specified, upon receipt thereof by the Board, the President or the Secretary, as the case may be. Unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective.

(c) All officers and agents appointed by the Board shall be subject to removal, with or without cause, at any time by the Board or by the action of the recordholders of a majority of the Shares entitled to vote thereon

SECTION 4.04 Vacancies. Any vacancy occurring in any office of the Corporation, for any reason, shall be filled by action of the Board. Unless earlier removed pursuant to Section 4.03 hereof, any officer appointed by the Board to fill any such vacancy shall serve only until such time as the unexpired term of his predecessor expires unless reappointed by the Board.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

SECTION 4.05 The Chief Executive Officer. The Chief Executive Officer (the “CEO”)_ shall be the chief executive officer of the Corporation and shall have general and active management and control of the business and affairs of the Corporation, subject to the control of the Board, and shall see that all orders and resolutions of the Board are carried into effect. The CEO shall have the power to call special meetings of Stockholders, to call special meetings of the Board and, if present, to preside at all meetings of Stockholders and all meetings of the Board. The CEO shall perform all duties incident to the office of CEO and all such other duties as may from time to time be assigned to him by the Board or these By-laws.

SECTION 4.06 The President. The President shall be the chief operating officer of the Corporation and shall have general and active management and control the operations of the Corporation, subject to the control of the Board, and shall see that all orders and resolutions of the Board are carried into effect. The President shall perform all duties incident to the office of President and all such other duties as may from time to time be assigned to him by the Board or these By-laws.

SECTION 4.07 Vice Chairmen, Vice Presidents and Managing Directors. Vice Chairmen, Vice Presidents and Managing Directors, if any, in order of their seniority or in any other order determined by the Board, shall generally assist the President and perform such other duties as the Board or the President shall prescribe, and in the absence or disability of the President, shall perform the duties and exercise the powers of the President. A Managing Director may be designated as a Senior Managing Director. A Vice President may be designated as an Executive Vice President, a Senior Vice President, a First Vice President, a Vice President or an Assistant Vice President.

SECTION 4.08 The Secretary. The Secretary shall, to the extent practicable, attend all meetings of the Board and all meetings of Stockholders and shall record all votes and the minutes of all proceedings in a book to be kept for that purpose, and shall perform the same duties for any committee of the Board when so requested by such committee. He or she shall give or cause to be given notice of all meetings of Stockholders and of the Board, shall perform such other duties as may be prescribed by the Board, the Chairman or the President and shall act under the supervision of the Chairman and the President. He or she shall keep in safe custody the seal of the Corporation and affix the same to any instrument that requires that the seal be affixed to it and which shall have been duly authorized for signature in the name of the Corporation and, when so affixed, the seal shall be attested

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

by his or her signature or by the signature of the Treasurer of the Corporation (the “Treasurer”) or an Assistant Secretary or Assistant Treasurer of the Corporation. He or she shall keep in safe custody the certificate books and stockholder records and such other books and records of the Corporation as the Board, the Chairman or the President may direct and shall perform all other duties incident to the office of Secretary and such other duties as from time to time may be assigned to him or her by the Board, the Chairman or the President.

SECTION 4.09 Assistant Secretaries. Assistant Secretaries of the Corporation (“Assistant Secretaries”), if any, in order of their seniority or in any other order determined by the Board, shall generally assist the Secretary and perform such other duties as the Board or the Secretary shall prescribe, and, in the absence or disability of the Secretary, shall perform the duties and exercise the powers of the Secretary.

SECTION 4.10 The Treasurer. The Treasurer shall have the care and custody of all the funds of the Corporation and shall deposit such funds in such banks or other depositories as the Board, or any officer or officers, or any officer and agent jointly, duly authorized by the Board, shall, from time to time, direct or approve. He shall disburse the funds of the Corporation under the direction of the Board and the President. He shall keep a full and accurate account of all moneys received and paid on account of the Corporation and shall render a statement of his accounts whenever the Board, the Chairman or the President shall so request. He shall perform all other necessary actions and duties in connection with the administration of the financial affairs of the Corporation and shall generally perform all the duties usually appertaining to the office of treasurer of a corporation. When required by the Board, he shall give bonds for the faithful discharge of his duties in such sums and with such sureties as the Board shall approve.

SECTION 4.11 Assistant Treasurers. Assistant Treasurers of the Corporation (“Assistant Treasurers”), if any, in order of their seniority or in any other order determined by the Board, shall generally assist the Treasurer and perform such other duties as the Board or the Treasurer shall prescribe, and, in the absence or disability of the Treasurer, shall perform the duties and exercise the powers of the Treasurer.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

ARTICLE V

CHECKS, DRAFTS, NOTES AND PROXIES

SECTION 5.01 Checks, Drafts and Notes. All checks, drafts and other orders for the payment of money, notes and other evidences of indebtedness issued in the name of the Corporation shall be signed by such officer or officers, agent or agents of the Corporation and in such manner as shall be determined from time to time, by resolution of the Board.

SECTION 5.02 Execution of Proxies. The President, or, in the absence or disability of both of them, any Vice Chairman, Vice President or Managing Director, may authorize, from time to time, the execution and issuance of proxies to vote shares of stock or other securities of other corporations held of record by the Corporation and the execution of consents to action taken or to be taken by any such corporation. All such proxies and consents, unless otherwise authorized by the Board, shall be signed in the name of the Corporation by the President or any Vice Chairman, Vice President or Managing Director.

ARTICLE VI

SHARES AND TRANSFERS OF SHARES

SECTION 6.01 Certificates Evidencing Shares. Shares shall be evidenced by (1) certificates in such form or forms as shall be approved by the Board or (2) they shall be uncertificated. Each registered holder shall be provided a certificate of stock representing the number of shares owned by such holder.

If certificates of stock are issued, they shall be issued in consecutive order and shall be numbered in the order of their issue, and shall be signed by the Chairman, the Chief Executive Officer, the President or any Vice Chairman, Vice President or Managing Director and by the Secretary, any Assistant Secretary, the Treasurer or any Assistant Treasurer; provided that if such a certificate is manually signed by one such officer, any other signature on the certificate may be a facsimile and, if such a certificate is countersigned by a transfer agent or registrar other than the Corporation or its employee, any other signature on the certificate may be a facsimile. No certificate for a fractional share of Common Stock shall be issued. In the event any such officer who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to hold such office or to be employed by the Corporation before such certificate is issued, such certificate may be issued by the Corporation with the same effect as if such officer had held such office on the date of issue.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

SECTION 6.02 Transfers of Shares. Transfers of Shares shall be made upon the books of the Corporation: (1) upon presentation of the certificates by the registered holder in person or by duly authorized attorney, or upon presentation of proper evidence of succession, assignment or authority to transfer the stock, and upon surrender of the appropriate certificate(s), or (2) in the case of uncertificated shares, upon receipt of proper transfer instructions from the registered owner of such uncertificated shares, or from a duly authorized attorney or from an individual presenting proper evidence of succession, assignment or authority to transfer the stock. The Corporation may impose such additional conditions to the transfer of its Shares as may be necessary or appropriate for compliance with applicable law or to protect the Corporation, a Transfer Agent or the Registrar from liability with respect to such transfer.

SECTION 6.03 Holder of Record. The Corporation shall be entitled to treat the holder of any Share or Shares of stock as the holder in fact thereof and accordingly shall not be bound to recognize any equitable or other claim to or interest in such share or on the part of any other person whether or not it shall have express or other notice thereof, save as expressly provided by the laws of the State of Delaware.

SECTION 6.04 Addresses of Stockholders. Each Stockholder shall designate to the Corporation an address at which notices of meetings and all other corporate notices may be served or mailed to such Stockholder, and, if any Stockholder shall fail to so designate such an address, corporate notices may be served upon such Stockholder by mail directed to the mailing address, if any, as the same appears in the stock ledger of the Corporation or at the last known mailing address of such Stockholder.

SECTION 6.05 Lost, Destroyed and Mutilated Certificates. Each recordholder of Shares shall promptly notify the Corporation of any loss, destruction or mutilation of any certificate or certificates evidencing any Share or Shares of which he is the recordholder. The Board, in its discretion, or any transfer agent thereunto duly authorized by the Board, may authorize the issue of a new certificate in place of any certificate theretofore issued and alleged to have been mutilated, lost, stolen or destroyed, upon the surrender of the

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

mutilated certificate or, in the case of loss, theft or destruction of the certificate, upon satisfactory proof of such loss, theft or destruction, and the Board may, in its discretion, require, and its transfer agents and registrars may so require, the recordholder of the Shares evidenced by the lost, stolen or destroyed certificate or his legal representative to give the Corporation a bond sufficient to indemnify the Corporation against any claim made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate.

SECTION 6.06 Regulations. The Board may make such other rules and regulations as it may deem expedient, not inconsistent with these By-laws, concerning the issue, transfer and registration of certificates evidencing Shares.

SECTION 6.07 Fixing Date for Determination of Stockholders of Record. In order that the Corporation may determine the Stockholders entitled to notice of or to vote at any meeting of Stockholders or any adjournment thereof, or to express consent to, or to dissent from, corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the Board may fix, in advance, a record date, which shall not be more than 60 nor less than 10 days before the date of such meeting, nor more than 60 days prior to any other such action. A determination of the Stockholders entitled to notice of or to vote at a meeting of Stockholders shall apply to any adjournment of such meeting; provided, however, that the Board may fix a new record date for the adjourned meeting.

ARTICLE VII

SEAL

SECTION 7.01 Seal. The Board may approve and adopt a corporate seal, which shall be in the form of a circle and shall bear the full name of the Corporation, the year of its incorporation and the words “Corporate Seal Delaware”.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

ARTICLE VIII

FISCAL YEAR

SECTION 8.01 Fiscal Year. The fiscal year of the Corporation shall end on the thirty-first day of December of each year unless changed by resolution of the Board.

ARTICLE IX

INDEMNIFICATION AND INSURANCE

SECTION 9.01 Indemnification. (a) The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Corporation) by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in, or not opposed to, the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in, or not opposed to, the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful.

(b) The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorney’s fees) actually and reasonably incurred by him in

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in, or not opposed to, the best interests of the Corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the Corporation unless and only to the extent that the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper.

(c) To the extent that a director, officer, employee or agent of the Corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Section 9.01(a) and (b) of these By-laws, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by him in connection therewith.

(d) Any indemnification under Section 9.01(a) and (b) of these By-laws (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in Section 9.01(a) and (b) of these By-laws. Such determination shall be made (i) by the Board by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (ii) if such a quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (iii) by the stockholders of the Corporation.

(e) Expenses (including attorneys’ fees) incurred by an officer or director in defending any civil, criminal, administrative or investigative action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation pursuant to this Article IX. Such expenses (including attorneys’ fees) incurred by other employees and agents may be so paid upon such terms and conditions, if any, as the Board deems appropriate.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

(f) The indemnification and advancement of expenses provided by, or granted pursuant to, other Sections of this Article IX shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any law, by-law, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in an official capacity and as to action in another capacity while holding such office.

(g) For purposes of this Article IX, references to “the Corporation” shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, employees or agents so that any person who is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, shall stand in the same position under the provisions of this Article IX with respect to the resulting or surviving corporation as he would have with respect to such constituent corporation if its separate existence had continued.

(h) For purposes of this Article IX, references to “other enterprises” shall include employee benefit plans, references to “fines” shall include any excise taxes assessed on a person with respect to an employee benefit plan; and references to “serving at the request of the Corporation” shall include any service as a director, officer, employee or agent of the Corporation which imposes duties on, or involves service by, such director, officer, employee or agent with respect to any employee benefit plan, its participants, or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner “not opposed to the best interests of the Corporation” as referred to in this Article IX.

(i) The indemnification and advancement of expenses provided by, or granted pursuant to, this Article IX shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person.

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By-laws of Ambac Financial Group, Inc.

Amended through May 8, 2007

SECTION 9.02 Insurance for Indemnification. The Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of Section 145 of the General Corporation Law.

ARTICLE X

AMENDMENTS

SECTION 10.01 Amendments. Any By-law (including these By-laws) may be adopted, amended or repealed by the vote of the recordholders of a majority of the Shares then entitled to vote at an election of Directors or by written consent of Stockholders pursuant to Section 2.14 hereof, or by vote of the Board or by a written consent of Directors pursuant to Section 3.09 hereof.

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EX-10.41

EXHIBIT 10.41

AMBAC 1997 EQUITY PLAN

(amended as of July 24, 2006)

1. Purposes

The purposes of the Ambac 1997 Equity Plan (the “Plan”) are to attract, retain and motivate key employees of the Company, to compensate them for their contributions to the growth and profits of the Company and to encourage them to own Common Stock.

2. Definitions

For purposes of the Plan, the following terms shall be defined as follows:

“Administrator” means the individual or individuals to whom the Committee delegates authority under the Plan in accordance with Section 3(d).

“Ambac” means Ambac Financial Group, Inc., a Delaware corporation.

“Award” means an award made pursuant to the terms of the Plan to an Eligible Individual in the form of Stock Options, Stock Appreciation Rights, Stock Awards, Restricted Stock Units, Performance Units or Other Awards.

“Award Agreement” means a written document approved in accordance with Section 3 which sets forth the terms and conditions of the Award to the Participant. An Award Agreement may be in the form of a certificate issued by Ambac or one of its Subsidiaries which is executed by an officer on behalf of Ambac or such Subsidiary but does not require the signature of the Participant.

“Board” means the Board of Directors of the Company.

“Code” means the Internal Revenue Code of 1986, as amended, and the applicable rulings and regulations (including any proposed regulations) thereunder.

“Committee” means the Compensation Committee of the Board, any successor committee thereto or any other committee appointed from time to time by the Board to administer the Plan. The Committee shall consist of at least two individuals and shall serve at the pleasure of the Board.

“Common Stock” means the Common Stock, par value $.01 per share, of the Company.

“Company” means Ambac and its Subsidiaries.

“Eligible Individuals” means the individuals described in Section 6 who are eligible for Awards under the Plan.

“Exchange Act” means the Securities Exchange Act of 1934, as amended, and the applicable rulings and regulations thereunder.

“Excluded Individual” means (i) any individual who is designated by the Company at the time of hire as not eligible to participate in the Plan or (ii) any individual who is treated or designated by the Company as an independent contractor, leased employee (including, without limitation, a “leased employee” as defined in Section 414(n) of the Code) or consultant. Excluded Individuals are not eligible to participate in or receive benefits under the Plan. If any Excluded Individual pursuant to the preceding clauses (i) or (ii) shall be determined by a court or federal, state or local regulatory or administrative authority to have served as a common law employee of the Company, such determination shall not alter such person’s status as an Excluded Individual for purposes of the Plan

“Fair Market Value” means, with respect to a share of Common Stock, the fair market value thereof as of the relevant date of determination, as determined in accordance with a valuation methodology approved by the Committee. In the absence of any alternative valuation methodology approved by the Committee, the Fair Market Value of a share of Common Stock shall equal the average of the highest and the lowest quoted selling price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange, or such other national securities exchange as may be designated by the Committee, or, in the event that the Common Stock is not listed for trading on a national securities exchange but is quoted on an automated system, on such automated system, in any such case on the valuation date (or, if there were no sales on the valuation date, the average of the highest and the lowest quoted selling prices as reported on said composite tape or automated system for the most recent day during which a sale occurred).

“Incentive Stock Option” means a Stock Option which is an “incentive stock option” within the meaning of Section 422 of the Code and designated by the Committee as an Incentive Stock Option in an Award Agreement.

“Nonqualified Stock Option” means a Stock Option which is not an Incentive Stock Option.

“Other Award” means any other form of award authorized under Section 13 of the Plan.

“Participant” means an Eligible Individual to whom an Award has been granted under the Plan.

“Performance Unit” means a performance unit granted to an Eligible Individual pursuant to Section 12 hereof.

“Predecessor Plan” means the AMBAC Inc. 1991 Stock Incentive Plan, as amended.

“Restoration Option” means a Stock Option that is awarded upon the exercise of a Stock Option earlier awarded under the Plan or the Predecessor Plan (an “Underlying Option”) for which the exercise price is paid in whole or in party by tendering shares of Common Stock owned by the Participant, where such Restoration Option (i) covers a number of shares of Common Stock no greater than the number of shares tendered in payment of the exercise price of the Underlying Option plus the number of shares withheld to pay taxes arising upon such exercise, (ii) the expiration date of the Restoration Option is no later than the expiration date of the Underlying Option and (iii) the exercise price per share of the Restoration Option is no less than the Fair Market Value per share of Common Stock on the date of exercise of the Underlying Option.

“Restricted Stock Unit” means a restricted stock unit granted to an Eligible Individual pursuant to Section 11 hereof.

“Stock Appreciation Right” means a right to receive all or some portion of the appreciation on shares of Common Stock granted to an Eligible Individual pursuant to Section 9 hereof.

“Stock Award” means a share of Common Stock granted to an Eligible Individual for no consideration other than the provision of services or offer for sale to an Eligible Employee at a purchase price determined by the Committee, in either case pursuant to Section 10 hereof.

“Stock Option” means an Award to purchase shares of Common Stock granted to an Eligible Individual pursuant to Section 8 hereof, which Award may be either an Incentive Stock Option or a Nonqualified Stock Option.

“Subsidiary” means (i) a corporation or other entity with respect to which Ambac, directly or indirectly, has the power, whether through the ownership of voting securities, by contract or otherwise, to

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elect at least a majority of the members of such corporation’s board of directors or analogous governing body, or (ii) any other corporation or other entity in which Ambac, directly or indirectly, has an equity or similar interest and which the Committee designates as a Subsidiary for purposes of the Plan.

“Substitute Award” means an Award granted in connection with a corporate transaction, such as a merger, combination, consolidation or acquisition of property or stock upon assumption of, or in substitution for, outstanding awards previously granted by a company or other entity.

3. Administration of the Plan

(a) Power and Authority of the Committee. The Plan shall be administered by the Committee, which shall have full power and authority, subject to the express provisions hereof:

(i) to select Participants from the Eligible Individuals;

(ii) to make Awards in accordance with the Plan;

(iii) to determine the number of shares of Common Stock subject to each Award or the cash amount payable in connection with an Award;

(iv) to determine the terms and conditions of each Award, including, without limitation, those related to vesting, forfeiture, payment and exercisability, and the effect, if any, of a Participant’s termination of employment with the Company, and including the authority to amend the terms and conditions of an Award after the granting thereof to a Participant in a manner that is not, without the consent of the Participant, prejudicial to the rights of such Participant in such Award;

(v) to specify and approve the provisions of the Award Agreements delivered to Participants in connection with their Awards;

(vi) to construe and interpret any Award Agreement delivered under the Plan;

(vii) to prescribe, amend and rescind rules and procedures relating to the Plan;

(viii) to vary the terms of Awards to take account of tax, securities law and other regulatory requirements of foreign jurisdictions;

(ix) subject to the provisions of the Plan and subject to such additional limitations and restrictions as the Committee may impose, to delegate to one or more officers of the Company some or all of its authority under the Plan;

(x) to employ such legal counsel, independent auditors and consultants as it deems desirable for the administration of the Plan and to rely upon any opinion or computation received therefrom; and

(xi) to make all other determinations and to formulate such procedures as may be necessary or advisable for the administration of the Plan.

(b) Plan Construction and Interpretation. The Committee shall have full power and authority, subject to the express provisions hereof, to construe and interpret the Plan.

(c) Determinations of Committee Final and Binding. All determinations by the Committee in carrying out and administering the Plan and in construing and interpreting the Plan shall be final, binding and conclusive for all purposes and upon all persons interested herein.

(d) Delegation of Authority. The Committee may, but need not, from time to time delegate some or all of its authority under the Plan to an Administrator consisting of one or more members of the Committee or of one or more officers of the Company; provided, however, that the Committee may not delegate its

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authority (i) to make Awards to Eligible Individuals who are officers of the Company who are delegated authority by the Committee hereunder, or (ii) under Section 16 of the Plan. Any delegation hereunder shall be subject to the restrictions and limits that the Committee specifies at the time of such delegation or thereafter. Nothing in the Plan shall be construed as obligating the Committee to delegate authority to an Administrator, and the Committee may at any time rescind the authority delegated to an Administrator appointed hereunder or appoint a new Administrator. At all times, the Administrator appointed under this Section 3(d) shall serve in such capacity at the pleasure of the Committee. Any action undertaken by the Administrator in accordance with the Committee’s delegation of authority shall have the same force and effect as if undertaken directly by the Committee, and any reference in the Plan to the Committee shall, to the extent consistent with the terms and limitations of such delegation, be deemed to include a reference to the Administrator.

(e) Liability of Committee. No member of the Committee shall be liable for any action nor determination made in good faith, and the members of the Committee shall be entitled to indemnification and reimbursement in the manner provided in Ambac’s Certificate of Incorporation and the By-laws as they may be amended from time to time. In the performance of its responsibilities with respect to the Plan, the Committee shall be entitled to rely upon information and advice furnished by the Company’s officers, the Company’s accountants, the Company’s counsel and any other party the Committee deems necessary, and no member of the Committee shall be liable for any action taken or not taken in reliance upon any such advice.

(f) Action by the Board. Anything in the Plan to the contrary notwithstanding, any authority or responsibility which, under the terms of the Plan, may be exercised by the Committee may alternatively be exercised by the Board.

4. Effective Date and Term

The Plan became effective on May 15, 1997 after approval by the Board and the stockholders of Ambac in 1997. Upon recommendation by the Board, the stockholders of Ambac adopted certain amendments to the Plan, including extending the term of the Plan by seven years to May 6, 2011

5. Shares of Common Stock Subject to the Plan

(a) General. Subject to adjustment as provided in Section 15(b) hereof, the number of shares of Common Stock that may be issued pursuant to Awards under the Plan (the “Section 5 Limit”) shall not exceed, in the aggregate:

(I) 14,000,000 shares; plus

(II) the number of shares of Common Stock that remain available for issuance under the Predecessor Plan as of the date this Plan is approved by the stockholders of the Company (increased by any shares of Common Stock subject to any award (or portion thereof) outstanding under the Predecessor Plan on such date which lapses, expires or is otherwise terminated without the issuance of such shares or is settled by the delivery of consideration other than shares).

Shares issued under this Plan may be either authorized but unissued shares, treasury shares or any combination thereof.

(b) Rules Applicable to Determining Shares Available for Issuance. For purposes of determining the number of shares of Common Stock that remain available for issuance, the following shares shall be added back to the Section 5 Limit and again be available for Awards:

(x) The number of shares tendered to pay the exercise price of a Stock Option or other Award; and

(y) The number of shares withheld from any Award to satisfy a Participant’s tax withholding obligations or, if applicable, to pay the exercise price of a Stock Option or other Award.

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In addition, any shares underlying Substitute Awards shall not be counted against the Section 5 Limit and shall not be subject to Section 5(c) below.

(c) Special Limits. Anything to the contrary in Section 5(a) above notwithstanding, but subject to Section 15(b) below, the following special limits shall apply to shares of Common Stock available for Awards under the Plan:

(i) The maximum number of shares that may be issued in the form of Stock Awards, or issued upon settlement of Restricted Stock Units or Other Awards, shall equal 4,000,000 shares, of which no more than a number of shares equal to 10% of the Section 5 Limit shall be in the form of Other Awards, provided, however, that any such Stock Awards, Restricted Stock Units or Other Awards that are issued in lieu of cash compensation that otherwise would be paid to a Participant, or in satisfaction of any other obligation owed by the Company to a Participant, shall not be counted against such limitation; and

(ii) The maximum number of shares of Common Stock that may be subject to Stock Options or Stock Appreciation Rights granted to any Eligible Individual in any fiscal year of the Company shall equal 600,000 shares plus any shares which were available under this Section 5(c) (ii) for Awards of Stock Options or Stock Appreciation Rights to such Eligible Individual in any prior fiscal year but which were not covered by such Awards.

(d) No Further Awards under Predecessor Plan. From and after the date this Plan is approved by the stockholders of the Company, no further awards shall be made under the Predecessor Plan.

6. Eligible Individuals

Awards may be granted by the Committee to individuals (“Eligible Individuals”) who are: (i) officers or other key employees of the Company; (ii) employees of joint ventures, partnerships or similar business organizations in which the Company has a direct or indirect equity interest; and individuals who provide services to any joint ventures or business organizations in which the Company may participate in the future. Excluded Individuals are not eligible to receive Awards under the Plan. Members of the Committee will not be eligible to receive Awards under the Plan. An individual’s status as an Administrator will not affect his or her eligibility to participate in the Plan.

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7. Awards in General

(a) Types of Award and Award Agreement. Awards under the Plan may consist of Stock Options, Stock Appreciation Rights, Stock Awards, Restricted Stock Units, Performance Units or Other Awards. Any Award described in Sections 8 through 13 of the Plan may be granted singly or in combination or tandem with any other Award, as the Committee may determine. Awards may be made in combination with, in replacement of, or as alternatives to grants of rights under any other employee compensation plan of the Company, including the plan of any acquired entity, or may be granted in satisfaction of the Company’s obligations under any such plan.

(b) Terms Set Forth in Award Agreement. The terms and provisions of an Award shall be set forth in a written Award Agreement approved by the Committee and delivered or made available to the Participant as soon as practicable following the date of the Award. The vesting, exercisability, payment and other restrictions applicable to an Award (which may include, without limitation, restrictions on transferability or provision for mandatory resale to the Company) shall be determined by the Committee and set forth in the applicable Award Agreement. Notwithstanding the foregoing, the Committee may accelerate (i) the vesting or payment of any Award, (ii) the lapse of restrictions on any Award or (iii) the date on which any Stock Option, Stock Appreciation Right or other Award first becomes exercisable.

(c) Termination of Employment and Change in Control. The Committee shall also have full authority to determine and specify in the applicable Award Agreement the effect, if any, that a Participant’s termination of employment for any reason will have on the vesting, exercisability, payment or lapse of restrictions applicable to an Award. The date of a Participant’s termination of employment for any reason shall be determined in the sole discretion of the Committee. Similarly, the Committee shall have full authority to determine the effect, if any, of a change in control of Ambac on the vesting, exercisability, payment or lapse of restrictions applicable to an Award, which effect may be specified in the applicable Award Agreement or determined at a subsequent time.

(d) Dividends and Dividend Equivalents. The Committee may provide Participants with the right to receive dividends or payments equivalent to dividends or interest with respect to an outstanding Awards, which payments can either be paid currently or deemed to have been reinvested in shares of Common Stock, and can be made in Common Stock, cash or a combination thereof, as the Committee shall determine.

8. Stock Options

(a) Terms of Stock Options Generally. A Stock Option shall entitle the Participant to whom the Stock Option was granted to purchase a specified number of shares of Common Stock during a specified period at a price that is determined in accordance with Section 8(b) below. Stock Options may be either Nonqualified Stock Options or Incentive Stock Options. The Committee will fix the vesting and exercisability conditions applicable to a Stock Option, provided that no Stock Option shall vest sooner than one year from the date of grant (subject to early vesting, if so provided by the Committee, upon death, disability, termination of employment or a change in control of the Company.

(b) Exercise Price. The exercise price per share of Common Stock purchasable under a Stock Option shall be fixed by the Committee at the time of grant or, alternatively, shall be determined by a method specified by the Committee at the time of grant; provided, however, that the exercise price per share shall be no less than 100% of the Fair Market Value per share on the date of grant (or it the exercise price is not fixed on the date of grant, then on such date as the exercise price is fixed); and provided further, that, except as provided in Section 15(b) below, the exercise price per share of Common Stock applicable to a Stock Option may not be adjusted or amended, including by means of amendment, cancellation or the replacement of such Stock Option with a subsequently awarded Stock Option. Notwithstanding the foregoing, the exercise price per share of a Stock Option that is a Substitute Award may be less than the Fair Market Value per share on the date of award, provided that the excess of:

(i) the aggregate Fair Market Value (as of the date such Substitute Award is granted) of the shares of Common Stock subject to the Substitute Award, over

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(ii) the aggregate exercise price thereof,

does not exceed the excess of:

(iii) the aggregate fair market value (as of the time immediately preceding the transaction giving rise to the Substitute Award, such fair market value to be determined by the Committee) of the shares of the predecessor entity that were subject to the award assumed or substituted for by the Company, over

(iv) the aggregate exercise price of such shares.

(c) Option Term. The term of each Stock Option shall be fixed by the Committee and shall not exceed ten years from the date of grant.

(d) Method of Exercise. Subject to the provisions of the applicable Award Agreement, the exercise price of a Stock Option may be paid in cash or previously owned shares or a combination thereof and, if the applicable Award Agreement so provides or the Committee otherwise so determines, in whole or in part through the withholding of shares subject to the Stock Option with a value equal to the exercise price. In accordance with the rules and procedures established by the Committee for this purpose, the Stock Option may also be exercised through a “cashless exercise” procedure approved by the Committee involving a broker or dealer approved by the Committee, that affords Participants the opportunity to sell immediately some or all of the shares underlying the exercised portion of the Stock Option in order to generate sufficient cash to pay the Stock Option exercise price and/or to satisfy withholding tax obligations related to the Stock Option.

9. Stock Appreciation Rights

(a) General. A Stock Appreciation Right shall entitle a Participant to receive, upon satisfaction of the conditions to the payment specified in the applicable Award Agreement, an amount equal to the excess, if any, of the Fair Market Value on the exercise date of the number of shares of Common Stock for which the Stock Appreciation Right is exercised, over the exercise price for such Stock Appreciation Right specified in the applicable Award Agreement. The exercise price per share of Common Stock covered by a Stock Appreciation Right shall be fixed by the Committee at the time of grant or, alternatively, shall be determined by a method specified by the Committee at the time of grant; provided, however, that, except as provided in Section 9(b) below, the exercise price per share shall be no less than 100% of the Fair Market Value per share on the date of grant (or if the exercise price is not fixed on the date of grant, then on such date as the exercise price is fixed); and provided further, that, except as provided in Section 15(b) below, the exercise price per share of Common Stock subject to a Stock Appreciation Right may not be adjusted or amended, including by means of amendment, cancellation or the replacement of such Stock Appreciation Right with a subsequently awarded Stock Appreciation Right. Notwithstanding the foregoing, the exercise price per share of a Stock Appreciation Right that is a Substitute Award may be less than the Fair Market Value per share on the date of award, provided, that such exercise price is not less than the minimum exercise price that would be permitted for an equivalent Stock Option as determined in accordance with Section 8(b) above. At the sole discretion of the Committee, payments to a Participant upon exercise of a Stock Appreciation Right may be made in cash, in shares of Common Stock having an aggregate Fair Market Value as of the date of exercise equal to such amount, or in a combination of cash and shares having an aggregate value as of the date of exercise equal to such amount.

(b) Stock Appreciation Rights in Tandem with Stock Options. A Stock Appreciation Right may be granted alone or in addition to other Awards, or in tandem with a Stock Option. A Stock Appreciation Right granted in tandem with a Stock Option may be granted either at the same time as such Stock Option or subsequent thereto. If granted in tandem with a Stock Option, a Stock Appreciation Right shall cover the same number of shares of Common Stock as covered by the Stock Option (or such lesser number of shares as the Committee may determine) and shall be exercisable only at such time or times and to the extent the

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related Stock Option shall be exercisable, and shall have the same term and exercise price as the related Stock Option (which, in the case of a Stock Appreciation Right granted after the grant of the related Stock Option, may be less than the Fair Market Value per share on the date of grant of the tandem Stock Appreciation Right). Upon exercise of a Stock Appreciation Right granted in tandem with a Stock Option, the related Stock Option shall be canceled automatically to the extent of the number of shares covered by such exercise; conversely, if the related Stock Option is exercised as to some or all of the shares covered by the tandem grant, the tandem Stock Appreciation Right shall be canceled automatically to the extent of the number of shares covered by the Stock Option exercise.

10. Stock Awards

(a) General. A Stock Award shall consist of one or more shares of Common Stock granted to a Participant for no consideration other than the provision of services (or, if required by applicable law in the reasonable judgment of the Company, for payment of the par value of such shares). Stock Awards shall be subject to such restrictions (if any) on transfer or other incidents of ownership for such periods of time, and shall be subject to such conditions of vesting, as the Committee may determine and as shall be set forth in the applicable Award Agreement.

(b) Distributions. Any shares of Common Stock or other securities of the Company received by a Participant to whom a Stock Award has been granted as a result of a stock distribution to holders of Common Stock or as a stock dividend on Common Stock shall be subject to the same terms, conditions and restrictions as such Stock Award.

11. Restricted Stock Units

An Award of Restricted Stock Units shall consist of a grant of units, each of which represents the right of the Participant to receive one share of Common Stock, subject to the terms and conditions established by the Committee in connection with the Award and set forth in the applicable Award Agreement. Upon satisfaction of the conditions to vesting and payment specified in the applicable Award Agreement, Restricted Stock Units will be payable in Common Stock or, if the Committee so determines, in cash, equal to the Fair Market Value of the shares subject to such Restricted Stock Units. Restricted Stock Units that are granted to an Eligible Individual in respect of corporate performance shall vest no sooner than one year from the date of grant, and Restricted Stock Units that are granted in connection with hiring or retention arrangements between the Company and a Participant shall vest no sooner than three years from the date of grant (subject, in either case, to early vesting, if so provided by the Committee, upon death, disability, termination of employment or a change in control of the Company).

12. Performance Units

Performance units may be granted as fixed or variable share- or dollar-denominated units subject to such conditions of vesting and time of payment as the Committee may determine and as shall be set forth in the applicable Award Agreement relating to such Performance Units. Performance Units may be paid in Common Stock, cash or a combination of Common Stock and cash, as the Committee may determine.

13. Other Awards

The Committee shall have the authority to specify the terms and provisions of other forms of equity-based or equity-related Awards not described above which the Committee determines to be consistent with the purpose of the Plan and the interests of the Company, which Awards may provide for cash payments based in whole or in part on the value or future value of Common Stock, for the acquisition or future acquisition of Common Stock, or any combination thereof. Other Awards shall also include cash payments (including the cash payment of dividend equivalents) under the Plan which may be based on one or more criteria determined by the Committee which are unrelated to the value of Common Stock and which may be granted in tandem with, or independent of, other Awards under the Plan.

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14. Certain Restrictions

(a) Transfers. Unless the Committee determines otherwise, no Award shall be transferable other than by will or by the laws of descent and distribution or pursuant to a qualified domestic relations order; provided, however, that the Committee may, in its discretion and subject to such terms and conditions as it shall specify, permit the transfer of an Award for no consideration to a Participant’s family members or to one or more trusts or partnerships established in whole or in part for the benefit of one or more of such family members (collectively, “Permitted Transferees”). Any Award transferred to a Permitted Transferee shall be further transferable only by will or the laws of descent and distribution or, for no consideration, to another Permitted Transferee of the Participant. The Committee may in its discretion permit transfers of Awards other than those contemplated by this Section.

(b) Exercise. During the lifetime of the Participant, a Stock Option, Stock Appreciation Right or similar-type Other Award shall be exercisable only by the Participant or by a Permitted Transferee to whom such Stock Option, Stock Appreciation Right or Other Award has been transferred in accordance with Section 14(a).

15. Recapitalization or Reorganization

(a) Authority of the Company and Stockholders. The existence of the Plan, the Award Agreements and the Awards granted hereunder shall not affect or restrict in any way the right or power of the Company or the stockholders of the Company to make or authorize any adjustment, recapitalization, reorganization or other change in the Company’s capital structure or its business, any merger or consolidation of the Company, any issue of stock or of options, warrants or rights to purchase stock or of bonds, debentures, preferred or prior preference stocks whose rights are superior to or affect the Common Stock or the rights thereof or which are convertible into or exchangeable for Common Stock, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise.

(b) Change in Capitalization. Notwithstanding any provision of the Plan or any Award Agreement, the number and kind of shares authorized for issuance under Section 5(a) above, including the maximum number of shares available under the special limits provided for in Section 5(c) above, shall be equitably adjusted by the Committee in the event of a stock split, stock dividend, recapitalization, reorganization, merger, consolidation, extraordinary dividend, split-up, spin-off, combination, exchange of shares, warrants or rights offering to purchase Common Stock at a price substantially below Fair Market Value or other similar corporate event affecting the Common Stock in order to preserve, but not increase, the benefits or potential benefits intended to be made available under the Plan. In addition, upon the occurrence of any of the foregoing events, the number of outstanding Awards and the number and kind of shares subject to any outstanding Award and the purchase price per share, if any, under any outstanding Award shall be equitably adjusted (including by payment of cash to a Participant) in the sole discretion of the Committee in order to preserve the benefits or potential benefits intended to be made available to Participants granted Awards. All adjustments provided for in this Section 15(b) shall be made by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final. Unless otherwise determined by the Committee, such adjusted Awards shall be subject to the same vesting schedule and restrictions to which the underlying Award is subject.

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16. Amendments

The Board or Committee may at any time and from time to time alter, amend, suspend or amend the Plan in whole or in part; provided, however, that any amendment which under the requirements of any applicable law or stock exchange rule must be approved by the stockholders of the Company shall not be effective unless and until such stockholder approval has been obtained in compliance with such law or rule; and provided further, that, except as contemplated by Section 15(b) above, the Board or Committee may not, without the approval of the Company’s stockholders, increase the maximum number of shares issuable under the Plan or reduce the exercise price of a Stock Option or Stock Appreciation Right. No termination or amendment of the Plan may, without the consent of the Participant to whom an Award has been granted, adversely affect the rights of such Participant under such Award. Notwithstanding any provision herein to the contrary, the Board or Committee shall have broad authority to amend the Plan or any Award under the Plan to take into account changes in applicable tax laws, securities laws, accounting rules and other applicable state and federal laws.

17. Miscellaneous

(a) Tax Withholding. The Company may require any individual entitled to receive a payment in respect of an Award to remit to the Company, prior to such payment, an amount sufficient to satisfy any Federal, state or local tax withholding requirements. The Company shall also have the right to deduct from all cash payments made pursuant to or in connection with any Award any Federal, state or local taxes required to be withheld with respect to such payments. The Company will not exercise this right in circumstances where the participant’s employment is located outside of the United States at the time of exercise or settlement, the participant is subject to income tax in that foreign jurisdiction, and there is no legal requirement on the Company to withhold tax and remit it to the revenue authority in that foreign jurisdiction. In the case of an Award payable in shares of Common Stock, the Company may permit such individual to satisfy, in whole or in part, such obligation to remit taxes by directing the Company to withhold shares of Common Stock that would otherwise be received by such individual, pursuant to such rules as the Committee may establish from time to time.

(b) No Right to Grants or Employment. No Eligible Individual or Participant shall have any claim or right to receive grants of Awards under the Plan. Nothing in the Plan or in any Award or Award Agreement shall confer upon any employee of the Company any right to continued employment with the Company or interfere in any way with the right of the Company to terminate the employment of any of its employees at any time, with or without cause.

(c) Other Compensation. Nothing in this Plan shall preclude or limit the ability of the Company to pay any compensation to a Participant under the Company’s other compensation and benefit plans and programs.

(d) Other Employee Benefit Plans. Payments received by a Participant under any Award made pursuant to the Plan shall not be included in, nor have any effect on, the determination of benefits under any other employee benefit plan or similar arrangement provided by the Company, unless otherwise specifically provided for under the terms of such plan or arrangement or by the Committee.

(e) Unfunded Plan. The Plan is intended to constitute an unfunded plan for incentive compensation. Prior to the payment or settlement of any Award, nothing contained herein shall give any Participant any rights that are greater than those of a general creditor of the Company. In its sole discretion, the Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Common Stock or payments in lieu thereof with respect to Awards hereunder.

(f) Securities Law Restrictions. The Committee may require each Eligible Individual purchasing or acquiring shares of Common Stock pursuant to a Stock Option or other Award under the Plan to represent to and agree with the Company in writing that such Eligible Individual is acquiring the shares for investment and not with a view to the distribution thereof. All certificates for shares of Common Stock

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delivered under the Plan shall be subject to such stock-transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations, and other requirements of the Securities and Exchange Commission, any exchange upon which the Common Stock is then listed, and any applicable federal or state securities law, and the Committee may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. No shares of Common Stock shall be issued hereunder unless the Company shall have determined that such issuance is in compliance with, or pursuant to an exemption from, all applicable federal and state securities laws.

(g) Compliance with Rule 16b-3. Notwithstanding anything contained in the Plan or in any Award Agreement to the contrary, if the consummation of any transaction under the Plan would result in the possible imposition of liability on a Participant pursuant to Section 16(b) of the Exchange Act, the Committee shall have the right, in its sole discretion, but shall not be obligated, to defer such transaction or the effectiveness of such action to the extent necessary to avoid such liability, but in no event for a period longer than six months.

(h) Award Agreement. In the event of any conflict or inconsistency between the Plan and any Award Agreement, the Plan shall govern, and the Award Agreement shall be interpreted to minimize or eliminate any such conflict or inconsistency.

(i) Expenses. The costs and expenses of administering the Plan shall be borne by the Company.

(j) Application of Funds. The proceeds received from the Company from the sale of Common Stock or other securities pursuant to Awards will be used for general corporate purposes.

(k) Applicable Law. Except as to matters of federal law, the Plan and all actions taken thereunder shall be governed by and construed in accordance with the laws of the State of Delaware without giving effect to conflicts of law principles.

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EX-10.42

EXHIBIT 10.42

AMBAC FINANCIAL GROUP, INC.

1997 NON-EMPLOYEE DIRECTORS EQUITY PLAN

(as amended through January 30, 2007)

1. Purpose

The purpose of the Ambac Financial Group, Inc. 1997 Non-Employee Directors Equity Plan (the “Plan”) is to promote the long-term growth and financial success of the Company by attracting, motivating and retaining non-employee directors of outstanding ability and assisting the Company in promoting a greater identity of interest between the Company’s non-employee directors and its stockholders.

The Plan replaces the AMBAC Inc. 1991 Non-Employee Directors Stock Plan (the “Predecessor Plan”). From and after the effective date of the Plan as provided in Section 11 below, no further awards shall be made under the Predecessor Plan.

2. Definitions

For purposes of the Plan, the following terms shall be defined as follows:

“Annual Award” means an Award of Director Options (made in respect of Annual Meetings up to and including the 2003 Annual Meeting) or Director Annual Stock Units (made in respect of Annual Meetings beginning with the 2004 Annual Meeting), in each case as provided in Section 7 below.

“Annual Meeting” means an annual meeting of the Company’s stockholders.

“Award” means any or all (as the context requires) of Director Annual Stock Units, Director Five-Year Stock Units and Director Options.

“Board” means the Board of Directors of the Company.

“Change in Control” means:

(i) the acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of the Common Stock then outstanding, but shall not include any such acquisition by:

(A) the Company;

(B) any Subsidiary of the Company;

(C) any employee benefit plan of the Company or of any Subsidiary of the Company;

(D) any Person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan;

(E) any Person who as of January 31, 1996 was the beneficial owner of 15% or more of the shares of Common Stock outstanding on such date unless and until such Person, together with all affiliates and associates of such Person, becomes the beneficial owner of 25% or more of the shares of Common Stock then outstanding whereupon a Change in Control shall be deemed to have occurred; or

(F) any Person who becomes the beneficial owner of 20% or more, or, with respect to a Person described in clause (E) above, 25% or more, of the shares of Common Stock then outstanding as a result of a reduction in the number of shares of Common Stock outstanding due to the repurchase of shares of Common Stock by the Company unless and until such Person, after becoming aware that such Person has become the beneficial owner of 20% or more, or 25% or more, as the case may be, of the then outstanding shares of Common Stock, acquires beneficial ownership of additional shares of Common Stock representing 1% or more of the shares of Common Stock then outstanding, whereupon a Change in Control shall be deemed to have occurred or

(ii) individuals who, as of the date this Plan is approved by the Board, constitute the Board, and subsequently elected members of the Board whose election is approved or recommended by at least a majority of such current members or their successors whose election was so approved or recommended (other than any subsequently elected members whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board), cease for any reason to constitute at least a majority of such Board; or

(iii) approval by the stockholders of the Company of (A) a merger or consolidation of the Company with any other corporation, (B) the issuance of voting securities of the Company in connection with a merger or consolidation of the Company (or any Subsidiary) pursuant to applicable stock exchange requirements, or (C) sale or other disposition of all or substantially all of the assets of the Company or the acquisition of assets of another corporation (each, a “Business Combination”), unless, in each case, immediately following such Business Combination, all or substantially all of the individuals and entities who were the beneficial owners of the Common Stock outstanding immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of the then outstanding shares of common stock and 70% of the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company’s assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the Common Stock.

“Common Stock” means the Common Stock of the Company, par value $.01 per share, or such other class or kind of shares or other securities as may be applicable under Section 13 below.

“Company” means Ambac Financial Group, Inc., a Delaware corporation, or any successor to substantially all its business.

“Director Account” means the bookkeeping record established for each Non-Employee Director. A Director Account is established only for purposes of measuring the value of the Company’s obligation to a Non-Employee Director in respect of Director Stock Units and earnings thereon and not to segregate assets or to identify assets that may be used to settle Director Stock Units.

“Director Annual Stock Unit” means a restricted stock unit granted to a Non-Employee Director pursuant to Section 7 hereof.

“Director Five-Year Stock Unit” means a restricted stock unit granted to a Non-Employee Director pursuant to Section 6 hereof.

“Director Option” means a right to purchase shares of Common Stock granted to a Non-Employee Director pursuant to Section 7 hereof.

“Director Stock Unit” means either a Director Five-Year Stock Unit or a Director Annual Stock Unit. A Director Stock Unit shall represent the right to receive one share of Common Stock upon satisfaction of the conditions to vesting and settlement specified in the Plan. Director Stock Units shall be settled exclusively in Common Stock.

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“Effective Date” means the effective date of the Plan provided for in Section 11 below.

“Fair Market Value” means, with respect to a share of Common Stock, the fair market value thereof as of the relevant date of determination, as determined in accordance with a valuation methodology approved by the Committee. In the absence of any alternative valuation methodology approved by the Committee, the Fair Market Value of a share of Common Stock shall equal the closing price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange, or such other national securities exchange as may be designated by the Committee, or in the event that the Common Stock is not listed for trading on a national securities exchange but is quoted on an automated quotation system, on such automated quotation system, in any such case on the valuation date (or if there were no sales on the valuation date, the closing price as reported on such composite tape or automated quotation system for the most recent day during which a sale occurred).

“Non-Employee Director” means a member of the Board who is not an employee of the Company or any of its subsidiaries.

“Permanent Disability” means a physical or mental impairment rendering a Non-Employee Director substantially unable to function as a member of the Board for any period of six consecutive months. Any dispute as to whether a Non-Employee Director is Permanently Disabled shall be resolved by a physician mutually acceptable to the Non-Employee Director and the Company, whose decision shall be final and binding upon the Non-Employee Director and the Company.

“Person” means any individual, firm, corporation, partnership or other entity.

“Predecessor Plan” has the meaning set forth in Section 1 above.

“Subsidiary” means (i) a corporation or other entity with respect to which the Company, directly or indirectly, has the power, whether through the ownership of voting securities, by contract or otherwise, to elect at least a majority of the members of such corporation’s board of directors or analogous governing body, or (ii) any other corporation or other entity in which the Company, directly or indirectly, has an equity or similar interest and which the Committee designates as a Subsidiary for purposes of the Plan.

3. Administration

(a) Administration by the Board. The Plan shall be administered by the Board, which may adopt rules and regulations it considers necessary or appropriate to carry out the Plan’s purposes. The Board’s interpretation and construction of any Plan provision shall be final and conclusive. The Board may, but need not, from time to time delegate some or all of its authority under the Plan to a committee consisting of one or more members of the Board, any such delegation to be subject to the restrictions and limits that the Board specifies at the time of such delegation or thereafter. References in the Plan to the “Board” shall, to the extent consistent with the terms and limitations of any such delegation, be deemed to include a reference to any such committee to which the Board’s authority hereunder has been delegated.

(b) Award Certificate. The terms and conditions of each grant of Director Stock Units and Director Options under the Plan shall be embodied in an award agreement or award certificate which shall incorporate the Plan by reference, shall indicate the date on which the Director Stock Units or Director Options were granted and the number of Director Stock Units or Director Options granted on such date.

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4. Shares Available

Subject to the provisions of Section 13 below, the maximum number of shares of Common Stock which may be issued under the Plan (the “Section 4 Limit”) shall be 360,000 shares plus the number of shares of Common Stock that remain available for issuance under the Predecessor Plan as of the date the Plan is approved by the stockholders of the Company (increased by any shares of Common Stock subject to any Award (or portion thereof) outstanding under the Predecessor Plan on such date which lapses, expires or is otherwise terminated without the issuance of such shares or is settled by the delivery of consideration other than shares). Subject to Section 13 below, of the shares of Common Stock available for issuance under the Plan, no more than 225,000 shares may be issued upon settlement of Director Stock Units. For purposes of determining the number of shares of Common Stock that remain available for issuance, there shall be added back to the Section 4 Limit and again be available under the Plan any shares of Common Stock tendered to pay the exercise price of a Director Option. Either authorized and unissued shares of Common Stock or treasury shares may be delivered pursuant to the Plan.

5. Eligibility

Director Stock Units and Director Options shall be granted only to Non-Employee Directors.

6. Director Five-Year Stock Units

(a) Grants of Director Five-Year Stock Units. Director Five-Year Stock Units shall be awarded under the Plan as follows:

(i) On the date of the Annual Meeting coincident with or first succeeding a Non-Employee Director’s initial election to the Board (or re-election to the Board after a period during which the Non-Employee Director did not serve on the Board), the Non-Employee Director shall receive a grant of a number of Director Five-Year Stock Units calculated by dividing (x) $210,000, by (y) the Fair Market Value of one share of Common Stock on the date of the relevant Annual Meeting.

(ii) As of the date of the Annual Meeting that is closest in time to the applicable vesting date of any Director Five-Year Stock Units in accordance with Section 6(b)(i) below, or the vesting date of any restricted shares under the Predecessor Plan in accordance with Section 6(c)(i) thereof, a Non-Employee Director shall receive an additional grant of Director Five-Year Stock Units (an “Additional Grant”), provided that (A) the Annual Meeting as of which the Additional Grant is to be made occurs during the term of the Plan as set forth in Section 11 below, and (B) the Non-Employee Director is standing for re-election at such Annual Meeting. The number of Director Five-Year Stock Units included in such Additional Grant shall be calculated by dividing (x) $210,000, by (y) the Fair Market Value of one share of Common Stock on the date of the relevant Annual Meeting in connection with which the Additional Grant is made.

(b) Vesting; Accelerated Vesting; Deferral.

(i) Director Five-Year Stock Units granted in respect of a given Annual Meeting, and any additional Director Five-Year Stock Units credited to a Director Account in respect of earnings or other distributions on such Director Five-Year Stock Units as provided in Section 6(c), shall vest on the fifth anniversary of the date of grant and shall be settled as soon as practicable thereafter, provided that the Non-Employee Director shall have remained a member of the Board continuously from the date of grant until the earlier of (A) such fifth anniversary or (B) if the Non-Employee Director declines to stand for re-election to the Board at the Annual Meeting held in the fifth calendar year following the date of grant, the date of such Annual Meeting.

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(ii) Notwithstanding the provisions of Section 6(b)(i) above, all Director Five-Year Stock Units granted to a Non-Employee Director shall immediately vest upon the first to occur of (A) a Non-Employee Director ceasing to be a member of the Board as a result of retirement from the Board in accordance with the retirement policy then applicable to Board members, (B) a Non-Employee Director ceasing to be a member of the Board as a result of death or Permanent Disability or (C) subject to the following sentence, a Change in Control of the Company, and shall be settled as soon as practicable thereafter. Notwithstanding the preceding sentence, if any Person commences a tender offer for shares of Common Stock which, if successfully completed, would result in a Change in Control, then all Director Five-Year Stock Units granted to a Non-Employee Director shall vest and be settled immediately prior to the scheduled expiration of such tender offer, and the Company shall have instituted procedures to enable the Non-Employee Director, if he so desires, to tender the shares issued upon settlement of such Director Five-Year Stock Units into such offer.

(c) Forfeiture of Grant. Except as provided in Section 6(b)(ii) above, all Director Five-Year Stock Units shall be forfeited, and all rights of the Non-Employee Director to or with respect to such Director Stock Units shall terminate without any obligation on the part of the Company, upon the termination of a Non-Employee Director’s service as a member of the Board prior to the date on which such Director Five-Year Stock Units vest in accordance with Section 6(b)(i) above.

7. Annual Awards

(a) General. As of the date of each Annual Meeting, commencing with the 1997 Annual Meeting, each Non-Employee Director shall automatically receive an Award of Director Options or Director Annual Stock Units as provided in this Section 7. A Director Option shall entitle a Non-Employee Director to purchase a specified number of shares of Common Stock during a specified period at an exercise price per share of Common Stock determined as provided below. All Director Options provided for herein shall have the general terms and conditions set forth in Section 9 below.

(b) Grants of Director Options. As of the date of each Annual Meeting, commencing with the 1997 Annual Meeting, each Non-Employee Director shall automatically receive Director Options to purchase 3,750 shares of Common Stock provided that the Non-Employee Director shall continue to serve as a director of the Company after such Annual Meeting, provided, however, that beginning with the 2004 Annual Meeting, no further Awards of Director Options shall be made. The exercise price per share of Common Stock of each Director Option provided for in this Section 7(b) shall be the Fair Market Value of one share of Common Stock on the date of the relevant Annual Meeting.

(c) Grants of Director Annual Stock Units. As of the date of each Annual Meeting, commencing with the 2004 Annual Meeting, each Non-Employee Director shall automatically receive a number of Director Annual Stock Units determined by dividing (i) $60,000 by (ii) the Fair Market Value of one share of Common Stock on the date of the relevant Annual Meeting.

(d) Grants to New Directors. A Non-Employee Director who is initially elected or appointed to the Board other than in connection with an Annual Meeting shall receive, as of the date of such initial election or appointment, (i) if such appointment is made prior to the 2004 Annual Meeting, Director Options to purchase a number of shares determined by multiplying 3,750 by a fraction (the “Proration Fraction”), the numerator of which is the number of full months remaining until the next Annual Meeting (starting with the month following the date of election or appointment and counting the month in which the next Annual Meeting is scheduled to occur as a full month) and the denominator of which is 12 and (ii) if such appointment is made after the 2004 Annual Meeting, a number of Director Annual Stock Units calculated by multiplying (x) the number of Director Annual Stock Units that were awarded to each Non-Employee Director in connection with the immediately preceding Annual Meeting, times (y) the Proration Fraction. (If the date of the next Annual Meeting has not been scheduled at the time of the Non-Employee Director’s initial election or appointment, it shall be assumed that the next Annual Meeting will occur in the same month as the immediately preceding Annual Meeting.) The exercise

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price per share of Common Stock of each Director Option provided for in this Section 7(d) shall be the Fair Market Value of one share of Common Stock on the date of the Non-Employee Director’s election or appointment to the Board.

(e) Vesting. Annual Awards shall vest as of the first anniversary of the date of grant, assuming that the Non-Employee Director has continued to serve as a member of the Board until the earlier of (A) such first anniversary or (B) if the Non-Employee Director declines to stand for reelection to the Board at the Annual Meeting held in the calendar year following the date of grant, the date of such Annual Meeting. Notwithstanding the preceding sentence, all Annual Awards shall be considered fully vested upon the earlier to occur of (X) termination of the Non-Employee Director’s service on the Board by reason of death or Permanent Disability or (Y) a Change in Control, provided, however, that if any Person commences a tender offer for shares of Common Stock which, if successfully completed, would result in a Change in Control, then all Annual Awards granted to a Non-Employee Director shall vest and, in the case of Director Annual Stock Units, be settled, immediately prior to the scheduled expiration of such tender offer, and the Company shall have instituted procedures to enable the Non-Employee Director, if he so desires, to tender the shares issued upon the exercise of Director Options or upon the settlement of Director Annual Stock Units into such offer.

8. General Terms and Conditions of Director Stock Units

(a) Accounts. As of any date as of which a Non-Employee Director is granted Director Stock Units, the Director Account of such Non-Employee Director will be credited with the number of Director Stock Units so granted. In the event that the Company pays any cash or other dividend or makes any other distribution in respect of the Common Stock, each Director Account will be credited with an additional number of Director Stock Units (including fractions thereof) determined by dividing (A) the amount of cash, or the value (as determined by the Board) of any securities or other property, paid or distributed in respect of one outstanding share of Common Stock by (B) the Fair Market Value of a share of Common Stock for the date of such payment or distribution, and multiplying the result of such division by (C) the number of Director Stock Units that were credited to the Director Account immediately prior to the date of the dividend or other distribution. Credits shall be made effective as of the date of the dividend or other distribution in respect of the Common Stock.

(b) Notwithstanding the provisions of Sections 6(b)(i), 6(b)(ii) and 7(e) above, a Non-Employee Director may elect to defer settlement of any or all Director Stock Units to a date subsequent to the vesting date of such Director Stock Units, provided that no such deferral may extend beyond the earlier of (i) the Non-Employee Director’s termination of service on the Board or (ii) the Non-Employee’s death. Settlement of any deferred Director Stock Units shall be made on or as soon as practicable following the date specified by the Non-Employee Director in the relevant deferral election or, if applicable, the earlier of the dates specified in clauses (i) and (ii) of the preceding sentence.

(c) Delivery of Share Certificates. As soon as practicable following the vesting of Director Stock Units as provided in Sections 6(b)(i), 6(b)(ii) or 7(e) above, or the date for deferred settlement as provided in Section 8(b) above, Director Stock Units shall be settled either by: (i) delivery to the Non-Employee Director of a share certificate for the number of shares corresponding to such Director Stock Units (any fractional Director Stock Unit shall be rounded up to the next whole Director Stock Unit) or (ii) the transfer of the corresponding number of shares equal to the number of Director Stock Units being settled (any fractional Director Stock Unit shall be rounded up to the next whole Director Stock Unit) to the brokerage account designated by the Non-Employee Director to the Company in writing prior to settlement. Shares delivered in settlement of Director Stock Units shall be free of all such restrictions, except any that may be imposed under applicable law or the Company’s trading policy.

(d) No Stockholder Rights. The crediting of Director Stock Units to a Director Account shall not confer on the relevant Non-Employee Director any rights as a stockholder of the Company.

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9. General Terms and Conditions Director Options

(a) Option Term. Each Director Option shall expire on the date of the Annual Meeting held in the seventh calendar year following the date of grant, subject to earlier expiration as provided herein, provided, however, that Director Options granted to a Non-Employee Director whose initial election occurs other than in connection with an Annual Meeting shall be treated for this purpose as though they had been granted at the first Annual Meeting following such initial election.

(b) Vesting; Accelerated Vesting; Effect of Termination of Service.

(i) Exercisability. Director Options shall become exercisable upon vesting.

(ii) Exercise Following Termination of Service. Following termination of a Non-Employee Director’s service on the Board, the former Non-Employee Director (or the former Non-Employee Directors’ estate, personal representative or beneficiary, as the case may be) shall have the right, subject to the other terms and conditions hereof, to exercise all Director Options that had vested as of or in connection with the termination of service:

(A) at any time within three years after the date of termination of service, if such termination was by reason of death, Permanent Disability or retirement from the Board in accordance with the retirement policy then in effect for Board members, or

(B) in all other cases, at any time within one year after the date of termination of service; subject, in all case, to earlier expiration of the Director Option pursuant to Section 9(a) above.

(c) Notice of Exercise. Subject to the other terms and conditions of the Plan, a Non-Employee Director may exercise all or any portion of a vested Director Option by giving written notice of exercise to the Company or its designated agent, provided, however, that no fewer than 10 shares of Common Stock may be purchased upon any exercise of a Director Option unless the number of shares purchased at such time is the total number of shares in respect of which the Director Option is then exercisable, and provided, further, that in no event shall the Option be exercisable for a fractional share. The date of exercise of an Option shall be the later of (i) the date on which the Company or its agent receives such written notice or (ii) the date on which the conditions provided in Sections 9(d) and 9(e) below are satisfied.

(d) Payment. The exercise price of a Director Option may be paid in cash or previously owned shares or a combination thereof or by any other method approved by the Board.

(e) Limitation on Exercise. A Director Option shall not be exercisable unless the Common Stock subject thereto has been registered under the Securities Act of 1933, as amended (the “1933 Act”), and qualified under applicable state “blue sky” laws in connection with the offer and sale thereof, or the Company has determined that an exemption from registration under the 1933 Act and from qualification under such state “blue sky” laws is available.

(f) Issuance of Shares. Subject to the foregoing conditions, as soon as is reasonably practicable after its receipt of a proper notice of exercise and payment of the exercise price for the number of shares with respect to which a Director Option is exercised, the Company shall deliver to the exercising Non-Employee Director, at the principal office of the Company or at such other location as may be acceptable to the Company and the Non-Employee Director, one or more stock certificates for the appropriate number of shares of Common Stock issued in connection with such exercise. Such shares shall be fully paid and nonassessable and shall be issued in the name of the Non-Employee Director. Notwithstanding the foregoing, the Board in its discretion may, subject to rules and procedures as it may adopt or impose from time to time, provide Non-Employee Directors with the opportunity to defer receipt of shares of Common Stock issuable upon exercise of Director Options.

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10. Transferability

Director Stock Units (including interests in a Director Account) and Director Options may not be transferred, pledged, assigned or otherwise disposed of except by will or the laws of descent and distribution or pursuant to a domestic relations order, provided, however, that Director Options may be transferred to a member or members of a Non-Employee Director’s immediate family (as defined below) or to one or more trusts or partnerships established in whole or in part for the benefit of one or more of such immediate family members (collectively as “Permitted Transferees”), subject to such rules and procedures as may from time to time be adopted or imposed by the Board. If a Director Stock Option is transferred to a Permitted Transferee, it shall be further transferable only by will or the laws of descent and distribution or, for no consideration, to another Permitted Transferee of the Non-Employee Director. A Non-Employee Director shall notify the Company in writing prior to any proposed transfer of a Director Option to a Permitted Transferee and shall furnish the Company, upon request, with information concerning such Permitted Transferee’s financial condition and investment experience. For purposes of the Plan, a Non-Employee Director’s “immediate family” means any child, stepchild, grandchild, spouse, son-in-law or daughter-in-law and shall include adoptive relationships; provided, however, that if the Company adopts a different definition of “immediate family” (or similar term) in connection with the transferability of employee stock options awarded to employees of the Company, such definition shall apply, without further action of the Board, to the Plan.

11. Term

(a) Effective Date; Expiration. The Effective Date shall be the date of the 1997 Annual Meeting, assuming the Plan is approved by the stockholders of the Company at such Annual Meeting. Unless earlier terminated in accordance with Section 12 below, the Plan shall expire on the date of the Annual Meeting held in 2011. Grants of Director Five-Year Stock Units and Director Annual Stock Units shall be made in connection with the Annual Meeting held in 2011, and shall be the last grants made under the Plan. Expiration of the Plan in connection with the Annual Meeting held in 2011 shall not affect Awards made prior to such Annual Meeting, which Awards shall remain outstanding subject to the terms hereof.

(b) Coordination with Predecessor Plan. Awards of “Directors Shares” (as such term is defined in the Predecessor Plan) shall be made under the Predecessor Plan in connection with the 1997 Annual Meeting. Assuming the Plan is approved by the stockholders of the Company at the 1997 Annual Meeting, no further Awards shall be made under the Predecessor Plan after the Effective Date. Awards outstanding under the Predecessor Plan (including Awards made in connection with the 1997 Annual Meeting) shall remain outstanding after the Effective Date subject to the terms thereof.

12. Amendments

Subject to the requirements of Section 13, the Board may at any time and from time to time alter, amend, suspend or terminate the Plan in whole of in part, including without limitation to amend the provisions for determining the amount of Director Stock Units or Directors Options to be issued to a Non-Employee Director, provided, however, that:

(i) any amendment which under the requirements of applicable law or stock exchange rule must be approved by the stockholders of the Company shall not be effective unless and until such stockholder approval has been obtained in compliance with such law or rule;

(ii) except as provided in Section 13 below, the Board may not, without the approval of the Company’s stockholders, increase the number of shares available for issuance under the Plan pursuant to Section 4 above or the number of Director Stock Units or Director Options to be issued to any Non-Employee Director pursuant to Section 6 or Section 7 above or reduce the exercise price of a Director Option.

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No termination or amendment of the Plan that would adversely affect a Non-Employee Director’s rights under the Plan with respect to any Award made prior to such action shall be effective as to such Non-Employee Director unless he or she consents thereto.

13. Adjustment of and Changes in Shares

In the event of any merger, consolidation, recapitalization, reclassification, stock split, stock dividend, distribution of property, special cash dividend, split-up, spin-off or other transaction or change in corporate structure affecting the shares, the Board, shall make (i) such equitable adjustments as it considers appropriate in the number and kind of shares authorized for issuance hereunder in order to preserve, but not increase, the benefits or potential benefits intended to be made available hereunder and/or (ii) such other adjustments as it deems appropriate. The Board’s determination as to what, if any, adjustments shall be made shall be final and binding on the Company and all Non-Employee Directors who receive grants under the Plan.

14. No Right to Re-election

Nothing in the Plan shall be deemed to create any obligation on the part of the Board to nominate any of its members for re-election by the Company’s stockholders, nor confer upon any Non-Employee Director the right to remain a member of the Board for any period of time, or at any particular rate of compensation.

15. Governing Law

The Plan and all agreements entered into under the Plan shall be construed in accordance with and governed by the laws of the State of Delaware.

16. No Restriction on Right of Company to Effect Corporate Changes

The Plan shall not affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalizations, reorganizations or other changes in the Company’s capital structure or its business, or any merger or consolidation of the Company, or any issue of stock or of options, warrants or rights to purchase stock or of bonds, debentures, preferred or prior preference stocks whose rights are superior to or affect the Common Stock or the rights thereof or which are convertible into or exchangeable for Common Stock, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise.

17. Unfunded Plan

The Plan is unfunded. Prior to the payment or settlement of any Award of Director Stock Units or the exercise of any Director Options, nothing contained herein shall give any non-Employee Director any rights that are greater than those of a general creditor of the Company. In its sole discretion, the Board may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Common Stock with respect to Awards hereunder.

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EX-10.43

EXHIBIT 10.43

AMBAC EXECUTIVE INCENTIVE PLAN

1. Purposes

The purposes of the Ambac Executive Incentive Plan (the “Plan”) are to enable Ambac Financial Group, Inc. (the “Company”) to attract, retain, motivate and reward executives and key employees of the highest caliber and quality by providing them with the opportunity to earn incentive compensation directly linked to the Company’s performance.

2. Definitions

For purposes of the Plan, the following terms shall be defined as follows:

“Board” means the Board of Directors of the Company.

“Code” means the Internal Revenue Code of 1986, as amended, and the applicable rulings and regulations (including any proposed regulations) thereunder.

“Committee” means the Compensation Committee of the Board, any successor committee thereto or any other committee appointed by the Board to administer the Plan. The Committee shall consist of at least two individuals, each of whom shall be qualified as an “outside director” (or shall satisfy any successor standard thereto) for purposes of Section 162(m), and shall serve at the pleasure of the Board; provided, however, that an inadvertent failure of any member of the Committee to be so qualified shall not invalidate any action or determination made by the Committee.

“Common Stock” means the Common Stock, par value $.01 per share, of the Company.

“Covered Employee” means a Participant who has been designated by the Committee as a Participant whose compensation for the relevant fiscal year may be subject to the limit on deductible compensation imposed by Section 162(m) of the Code.

“Disability” means eligibility for disability benefits under the terms of the Company’s long-term disability plan in effect at the time the Participant becomes disabled.

“Equity Plan” means the AMBAC 1997 Equity Incentive Plan and any successor or similar plan of the Company.

“Fair Market Value” means the closing price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange, or such other national securities exchange as may be designated by the Committee, or in the event that the Common Stock is not listed for trading on a national securities exchange but is quoted on an automated quotation system, on such automated quotation system, in any such case on the valuation date (or if there were no sales on the valuation date, the closing price as reported on such composite tape or automated quotation system for the most recent day during which a sale occurred).

“Participant” means each executive officer, senior officer or key employee of the Company or a Subsidiary whom the Committee designates as a participant under the Plan.

“Performance Period” means each fiscal year of the Company or such other period as may be designated by the Committee.

“Performance Targets” means the targets related to the performance goals designated in Section 4(d), which Performance Targets will be established by the Committee for a Performance Period.

“Section 162(m)” means Section 162(m) of the Code.

“Subsidiary” means (i) a corporation or other entity with respect to which the Company, directly or indirectly, has the power, whether through the ownership of voting securities, by contract or otherwise, to elect at least a majority of the members of such corporation’s board of directors or analogous governing body, or (ii) any other corporation or other entity in which the Company, directly or indirectly, has an equity or similar interest and which the Committee designates as a Subsidiary for purposes of the Plan.

3. Administration

(a) Power and Authority of the Committee. The Plan shall be administered by the Committee which shall have full power and authority, subject to the express provisions hereof:

(i) to select Participants from executive officers, senior officers and key employees of the Company;

(ii) to establish the Performance Targets for achievement during a Performance Period and to determine whether such Performance Targets have been achieved;

(iii) to determine the cash amount and/or number of shares of Common Stock payable in connection with an award;

(iv) to prescribe, amend and rescind rules and procedures relating to the Plan;

(v) to vary the terms of awards to take account of tax, securities law and other regulatory requirements of foreign jurisdictions;

(vi) subject to the provisions of the Plan and subject to such additional limitations and restrictions as the Committee may impose, to delegate to one or more officers of the Company some or all of its authority under the Plan;

(vii) to employ such legal counsel, independent auditors and consultants as it deems desirable for the administration of the Plan and to rely upon any opinion or computation received therefrom; and

(viii) to make all other determinations and to formulate such procedures as may be necessary or advisable for the administration of the Plan.

(b) Plan Construction and Interpretation. The Committee shall have full power and authority, subject to the express provisions hereof, to construe and interpret the Plan.

(c) Determinations of Committee Final and Binding. All determinations by the Committee in carrying out and administering the Plan and in construing and interpreting the Plan shall be final, binding and conclusive for all purposes and upon all persons interested herein.

(d) Liability of Committee. No member of the Committee shall be liable for any action nor determination made in good faith, and the members of the Committee shall be entitled to indemnification and reimbursement in the manner provided in the Company’s Certificate of Incorporation as it may be amended from time to time. In the performance of its responsibilities with respect to the Plan, the Committee shall be entitled to rely upon information and advice furnished by the Company’s officers, the Company’s accountants, the Company’s counsel and any other party the Committee deems necessary, and no member of the Committee shall be liable for any action taken or not taken in reliance upon any such advice.

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4. Awards

(a) Performance Targets. The Committee shall determine in its sole discretion whether any executive officer, senior officer or other employee of the Company shall have the opportunity to earn incentive compensation under this Plan during any Performance Period. If the Committee decides to offer such opportunity to one or more executive officers, senior officers or other employees of the Company, then no later than 90 days after the beginning of a Performance Period (or such other time as may be required or permitted by Section 162(m)), the Committee shall (i) designate each Participant for the Performance Period, (ii) select from the performance goals set forth in Section 4(d) below the performance goal or goals to be applicable to the Performance Period, (iii) establish specific Performance Targets related to such performance goals and the incentive amounts which may be earned for the Performance Period by each Participant and (iv) specify the relationship between Performance Targets and the incentive amount to be earned by each Participant for the Performance Period. The Committee may specify that the incentive amount for a Performance Period will be earned if the applicable Performance Target is achieved for one performance goal or for any one of a number of performance goals. The Committee may also provide that the incentive amount for a Performance Period will be earned only if a Performance Target is achieved for more than one performance goal, or that the incentive amount to be earned for a given Performance Period will vary based upon different levels of achievement of the applicable Performance Targets.

(b) Following the completion of each Performance Period, the Committee shall certify in writing whether the applicable Performance Targets have been achieved for such Performance Period and the incentive amounts, if any, payable to Participants for such Performance Period. In determining the incentive amount earned by a Participant for a given Performance Period, the Committee shall have the right to reduce (but not to increase) the incentive amount payable at a given level of performance to take into account additional factors that the Committee may deem relevant to the assessment of individual or corporate performance for the Performance Period.

(c) Payment of Awards; Maximum Limitation. Anything in this Plan to the contrary notwithstanding, the maximum aggregate incentive amount that may be earned under the Plan by a Participant for all Performance Periods beginning in any given fiscal year of the Company shall be $5,000,000.

(d) Performance Goals. For purposes of this Plan, the performance goals from which the Committee shall establish Performance Targets applicable to specific Performance Periods shall be limited to the following:

(i) return on equity;

(ii) core earnings/operating earnings growth;

(iii) total return to stockholders;

(iv) expense management;

(v) risk management

(vi) market share;

(vii) industry leadership/image building;

(viii) new products/initiatives;

(ix) organizational development/corporate culture;

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each of which may be established (x) on a corporate-wide basis or with respect to one or more operating units, divisions, acquired businesses, minority investments, partnerships or joint ventures, or, where applicable, (y) on a relative or an absolute basis or (z) on a per share or an aggregate basis.

(e) Adjustments. Certain adjustments shall apply to the Performance Targets to take into account any one or more of the following with respect to the relevant Performance Period;

(i) the gain, loss, income or expense resulting from changes in accounting principles that become effective during the Performance Period;

(ii) the gain, loss, income or expense reported publicly by the Company with respect to the Performance Period that are extraordinary or unusual in nature or infrequent in occurrence as defined by the United States Generally Accepted Accounting Principles (GAAP), excluding gains or losses on the early extinguishment of debt;

(iii) the gains or losses resulting from, and the direct expenses incurred in connection with, the disposition of a business, in whole or in part, or the sale of investments or non-core assets;

(iv) the impact of impairment of tangible or intangible assets as defined by GAAP;

(v) the impact of restructuring or business recharacterization activities, including but not limited to reductions in force, as reported publicly by the Company; and

(vi) the impact of investments or acquisitions made during the year.

5. Termination of Employment

If a Participant’s employment with the Company or a Subsidiary terminates during a Performance Period by reason of death, Disability or retirement or with the approval of the Committee, the Participant may, subject to Section 4, hereof, receive a payment. If a Participant’s employment with the Company or a Subsidiary terminates during a Performance Period for any reason other than death, Disability or retirement or other than with the approval of the Committee, the Participant’s participation in the Plan shall terminate forthwith and he or she shall not be entitled to an award for such Performance Period.

6. Payment of Awards

Payment of awards determined under Section 4 shall be made to each Participant as soon as practicable after the Committee determines that the applicable Performance Targets have been achieved. The Committee in its sole discretion shall determine whether awards shall be payable in cash, in the form of stock awards or restricted stock units issued pursuant to an Equity Plan or from treasury, or in any combination thereof. If the Committee determines that an award shall be paid in the form of stock awards or restricted stock units issued under an Equity Plan or from treasury, then for purposes of determining the number of shares of Common Stock subject to an award the Committee will value such shares at a discount to Fair Market Value to reflect any restrictions, conditions and limitations set forth in the relevant Equity Plan or the applicable award agreement or certificate or otherwise applicable to the shares, provided, that such discount shall not exceed 50% of the Fair Market Value as of the relevant date of determination.

7. Effective Date; Term

The Plan shall become effective upon its adoption by the Board subject to its approval by the stockholders of the Company. Prior to such stockholder approval, the Committee may grant awards conditioned on stockholder approval. If such stockholder approval is not obtained at or before the first annual meeting of stockholders to occur after the adoption of the Plan by the Board (including any adjournment or adjournments thereof), the Plan and any awards made hereunder shall terminate ab initio and be of no further force and effect. Unless earlier terminated in accordance with Section 8 below, no award shall be made under the Plan with respect to Performance Periods beginning after January 1, 2010.

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8. Amendment and Termination

Notwithstanding Section 7, the Board or the Committee may at any time amend, suspend, discontinue or terminate the Plan; provided, however, that no such action shall be effective without approval by the stockholders of the Company to the extent necessary to continue to qualify the amounts payable hereunder to Covered Employees as performance-based compensation under Section 162(m).

9. Miscellaneous

(a) Tax Withholding. No later than the date as of which an amount first becomes includable in the gross income of the Participant for applicable income tax purposes with respect to any award under the Plan, the Participant shall pay to the Company or make arrangements satisfactory to the Committee regarding the payment of any federal, state or local taxes of any kind required by law to be withheld with respect to such amount. In the case of an award that is payable in shares of Common Stock, the Company may permit the Participant to satisfy, in whole or in part, such obligation to remit taxes by directing the Company to withhold shares of Common Stock that would otherwise be received by such individual, pursuant to such rules as the Committee may establish from time to time.

(b) No Rights to Awards or Employment. No Participant shall have any claim or right to receive awards under the Plan. Nothing in the Plan shall confer upon any employee of the Company any right to continued employment with the Company or interfere in any way with the right of the Company to terminate the employment of any of its employees at any time, with or without cause.

(c) Other Compensation. Nothing in this Plan shall preclude or limit the ability of the Company to pay any compensation to a Participant under the Company’s other compensation and benefit plans and programs, including without limitation any Equity Plan or bonus plan or program.

(d) No Limitation on Corporate Actions. Nothing contained in the Plan shall be construed to prevent the Company or any Subsidiary from taking any corporate action, which is deemed by it to be appropriate or in its best interest, whether or not such action would have an adverse effect on any awards made under the Plan. No Participant, beneficiary or other person shall have any claim against the Company or any Subsidiary as a result of any such action.

(e) Unfunded Plan. The Plan is intended to constitute an unfunded plan for incentive compensation. Prior to the payment of any award, nothing contained herein shall give any Participant any rights that are greater than those of a general creditor of the Company. In its sole discretion, the Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver payment in cash or Common Stock with respect to awards hereunder.

(f) Non-Transferability. Except as expressly provided herein, no Participant or beneficiary shall have the power or right to sell, transfer, assign, pledge or otherwise encumber or dispose of the Participant’s interest under the Plan.

(g) Designation of Beneficiary. A Participant may designate a beneficiary or beneficiaries to receive any payments which may be made following the Participant’s death. Such designation may be changed or canceled at any time without the consent of such beneficiary. Any such designation, change or cancellation must be made in a form approved by the Committee and shall not be effective until received by the Committee. If a Participant does not designate a beneficiary, or the designated beneficiary or beneficiaries predeceases the Participant, any payments which may be made following the Participant’s death shall be made to the Participant’s estate.

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(h) Severability. If any provision of this Plan is held unenforceable, the remainder of the Plan shall continue in full force and effect without regard to such unenforceable provision and shall be applied as though the unenforceable provision were not contained in the Plan.

(i) Expenses. The costs and expenses of administering the Plan shall be borne by the Company.

(j) Governing Law. The Plan and all actions taken thereunder shall be governed by and construed in accordance with and governed by the laws of the State of New York, without reference to the principles of conflict of laws.

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EX-10.44

EXHIBIT 10.44

AMBAC FINANCIAL GROUP, INC.

DEFERRED COMPENSATION PLAN

FOR OUTSIDE DIRECTORS

Effective as of December 1, 1993,

As Amended through December 4, 2006

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AMBAC FINANCIAL GROUP, INC.

DEFERRED COMPENSATION PLAN FOR

OUTSIDE DIRECTORS

1. Definitions

“Account” and “Deferred Compensation Account” are used interchangeably and mean the bookkeeping record established for each Participant. A Deferred Compensation Account is established only for purposes of measuring a Deferred Benefit and not to segregate assets or to identify assets that may be used to pay a Deferred Benefit.

“Account Value” means the amount reflected on the books and records of the Company as the value of a Participant’s Deferred Compensation Account at any date of determination, as determined in accordance with this Plan.

“Annual Fees” means the cash portion of (i) any annual fee payable to an Outside Director for service on the Board, (ii) any other fee determined on an annual basis and payable for service on (as distinguished from attendance at meetings of), or for acting as chairperson of, any committee of, or as Presiding Director of the Board and (iii) any similar annual fee payable in respect of service on the board of directors of any Subsidiary or any committee of any such board of directors.

“Beneficiary” or “Beneficiaries” means a person or other entity designated by a Participant on a Beneficiary Designation Form to receive Deferred Benefit payments in the event of the Participant’s death.

“Beneficiary Designation Form” means a document, in form approved by the Committee, to be used by Participants to name their respective Beneficiaries.

“Board” means the Board of Directors of the Company.

“Cash Deferral Option” means a Performance Option under which the Deferred Amount credited to a Participant’s Deferred Compensation Account is carried as a cash balance to which interest equivalents are credited from time to time as provided in Section 6(c)(i).

“Committee” means the Compensation Committee of the Board or any successor committee thereto.

“Common Stock” means the Company’s common stock, par value $0.01 per share.

“Conversion Date” has the meaning assigned to such term in Section 6(e).

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“Deemed Capital Gain Tax Charge” has the meaning assigned to such term in Section 6(c).

“Deferral Election” means the election of a Participant, made in accordance with the terms and conditions of the Plan, to defer all or a portion of his/her Directors Fees for a Deferral Year.

“Deferral Election Form” means a document, in form approved by the Committee, pursuant to which a Participant makes a Deferral Election.

“Deferral Year” means the calendar year, starting with calendar year 1994. If an individual becomes eligible to participate in the Plan after the commencement of a Deferral Year, the Deferral Year for the individual shall be the remainder of such Deferral Year.

“Deferred Amount” means the amount of Directors Fees, deferred by a Participant pursuant to a Deferral Election.

“Deferred Benefit” means the amount that will be paid on a deferred basis under the Plan to a Participant who has made a Deferral Election. A Participant’s Deferred Benefit will equal the Account Value of his or her Deferred Compensation Account, calculated as provided herein.

“Director Fees” means the aggregate of a Participant’s Annual Fees and Meeting Fees.

“Election Date” means December 31 of the year preceding the beginning of the Deferral Year, provided, however, that if an individual becomes an Outside Director for the first time during a Deferral Year, that Outside Director’s Election Date for such Deferral Year is any day within thirty days of the date he/she becomes an Outside Director.

“Exchange Act” means the Securities Exchange Act of 1934, as amended.

“Fair Market Value” of a share of Common Stock means the closing price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange, or such other national securities exchange as may be designated by the Committee, or in the event that the Common Stock is not listed for trading on a national securities exchange but is quoted on an automated quotation system, on such automated quotation system, in any such case on the valuation date (or if there were no sales on the valuation date, the closing price as reported on such composite tape or automated quotation system for the most recent day during which a sale occurred).

“Meeting Fees” means (i) any meeting fee payable in respect of attendance at or participation in meetings of the Board or any committee of the Board or any meeting of the stockholders of the Company and (ii) any similar meeting fee payable in respect of service on the board of directors of any Subsidiary or any committee of any such board of directors.

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“Outside Director” means a duly-elected member of the Board who is not an employee of the Company or any Subsidiary.

“Participant” means an Outside Director who participates in the Plan pursuant to Section 4.

“Performance Option” means the performance options made available from time to time for selection by Participants to measure the return (positive or negative) to be attributed to Deferred Amounts.

“Phantom Stock Option” means a Performance Option under which a Deferred Amount is credited to a Participant’s Deferred Compensation Account as a number of Phantom Stock Units.

“Phantom Stock Unit” means a bookkeeping unit representing one share of Common Stock.

“Subsidiary” means any corporation 50 percent or more of the voting stock of which is owned directly or indirectly by the Company.

2. Purpose

The purpose of the Plan is to provide the Company’s Outside Directors an opportunity to defer payment of all or part of their Directors Fees in accordance with the terms and conditions set forth herein.

3. Administration

(a) Authority. The Committee will be responsible for administering the Plan. The Committee will have authority to adopt such rules as it may deem appropriate to carry out the purposes of the Plan, and shall have authority to interpret and construe the provisions of the Plan and any agreements under the Plan and to make determinations pursuant to any Plan provision. Each interpretation, determination or other action made or taken by the Committee pursuant to the Plan shall be final and binding on all persons. No member of the Committee shall be liable for any action or determination made in good faith, and the members of the Committee shall be entitled to indemnification and reimbursement in the manner provided in the Company’s Amended and Restated Certificate of Incorporation as it may be amended from time to time.

(b) Delegation. The Committee may designate a committee composed of one or more members of the Board to carry out its responsibilities under such conditions as it may set.

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4. Eligibility

(a) Directors. Any Outside Director may participate in the Plan.

(b) Becoming a Participant. An Outside Director becomes a Participant for any Deferral Year by filing a Deferral Election Form according to Section 5 of the Plan.

5. Deferral Elections

(a) General Provisions. A Participant may elect to defer all or a specified percentage (in multiples of 10 percent) of Directors Fees for a Deferral Year, in the manner provided in this Section 5. A Participant’s Deferred Benefit is at all times nonforfeitable.

(b) Deferral Election Forms. Before the Election Date applicable to a Deferral Year, each Outside Director will be provided with a Deferral Election Form and a Beneficiary Designation Form. In order for an Outside Director to participate in the Plan for a given Deferral Year, a Deferral Election Form, completed and signed by him/her, must be delivered to the Secretary of the Board on or prior to the applicable Election Date. An Outside Director electing to participate in the Plan for a given Deferral Year shall indicate on his/her Deferral Election Form:

(i) the percentage of Director Fees for the applicable Deferral Year to be deferred;

(ii) the allocation of the Deferred Amount among the several Performance Options then available to Participants, in accordance with the terms and conditions of Section 6(b); and

(iii) the Participant’s election either to have distribution of his/her Deferred Benefit commence following termination of service as an Outside Director or to have such distribution commence as of a date specified on such Form, provided, however, that any such election concerning the commencement of distribution of a Participant’s Deferred Benefit shall be subject to the terms and conditions of Section 6(e).

(c) Effect of No Deferral Election. An Outside Director who does not submit a completed and signed Deferral Election Form to the Secretary of the Board before the relevant Election Date is not a Participant for the Deferral Year and may not defer his/her Directors Fee for the Deferral Year.

(d) Revocation of Deferral Election.

(i) A Participant may revoke a Deferral Election applicable to a Deferral

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Year, but only pursuant to the procedure described in subsection (ii) below. Any purported revocation that does not comply with subsection (ii) below will not be given effect.

(ii) To be effective, a revocation must be in writing and signed by the Participant, must express the Participant’s intention to revoke his Deferral Election applicable to that Deferral Year, and must be delivered to the Secretary of the Board before the close of business on the Election Date applicable to such Deferral Year. For example, to revoke a Deferral Election relating to calendar year 2004, a written revocation of such Deferral Election must be delivered to the Secretary of the Board before the close of business on December 31, 2003.

6. Deferred Compensation Accounts; Distributions

(a) Deferred Compensation Accounts.

(i) Establishment of Accounts. A Participant’s deferrals will be credited to a Deferred Compensation Account set up for that Participant. Each Deferred Compensation Account will be credited with Deferred Amounts, as provided in Section 6(b), and credited (or charged) with earnings (or loss) as provided in Section 6(c).

(ii) Crediting of Deferred Amounts.

Director Fees. As of the dividend payment date following the last calendar quarter, an Outside Director’s Deferred Compensation Account will be credited with (A) 25% of Annual Fees deferred for the Deferral Year in which such quarter occurs and (B) 100% of deferred Meeting Fees earned during such quarter.

(b) Allocations Among Performance Options. A Participant shall have the right to allocate the Deferred Amount for any Deferral Year, in minimum allocations of at least 10%, among one or more Performance Options made available from time to time under the Plan. The Performance Options generally available to Participants shall include:

(i) A Cash Deferral Option;

(ii) A Phantom Stock Option; and

(iii) Such other Performance Options as the Committee may make available to Participants from time to time. Deemed allocations among the available Performance Options shall be made exclusively for the purpose of determining the Account Value from time to time, and the Company will have no obligation to invest amounts corresponding to Deferred Amounts in investment vehicles corresponding to the Performance Options selected by the Participant. Participants may change the deemed allocation of their Account Value among the Performance Options then available under the Plan in accordance with procedures established by the

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Committee from time to time; provided, however, that, unless otherwise determined by the Committee, no such reallocation shall be made more frequently than quarterly; and provided further that no such reallocation may result in less than 10% of the Account Value being deemed allocated to any single Performance Option.

(c) Determination of Account Value.

The Company will from time to time calculate the Account Value based on the Participant’s Deferred Amounts and his/her then-effective elections with respect to deemed allocation of the Account among the available Performance Options. Such calculation will be based on the best information available to the Company as of the date of determination, which information may include estimates. In addition, the following shall apply:

(i) Amounts allocated to the Cash Deferral Option (including amounts resulting from the conversion of Phantom Stock Units as provided in Section 6(c)(ii)), will be credited with interest equivalents as of the first business day of each calendar quarter based upon the average daily balance credited to such Cash Option (which balance shall include any earnings on amounts so credited pursuant to this Section 6(c)(i)) during the preceding quarter. Interest equivalents will be calculated using the 90-day commercial paper composite rate published by the Federal Reserve Bank as of the last business day of such preceding calendar quarter, or such other rate as the Committee may designate from time to time by resolution.

(ii) The number of Phantom Stock Units credited to a Participant’s Deferred Compensation Account (including fractions of Phantom Stock Units) will be determined by dividing (A) the amount of Director Fees deferred by (B) the Fair Market Value of a share of Common Stock on the date of crediting.

(iii) If the Company pays any cash or other dividend or makes any other distribution in respect of the Common Stock, each Phantom Stock Unit credited to the Deferred Compensation Account of a Participant will be credited with an additional number of Phantom Stock Units (including fractions thereof) determined by dividing (A) the amount of cash, or the value (as determined by the Committee) of any securities or other property, paid or distributed in respect of one outstanding share of Common Stock by (B) the Fair Market Value of a share of Common Stock on the date of such payment or distribution. Such credit shall be made effective as of the date of the dividend or other distribution in respect of the Common Stock.

(iv) In determining the value attributable to that portion of a Participant’s Deferred Compensation Account allocated to Performance Options other than the Cash Deferral Option and the Phantom Share Option, the Company will track the rate of return (positive or negative) over the relevant measurement period of the investment fund, index or other vehicle by reference to which the Performance Option is defined.

(v) Upon any reallocation of all or any portion of a Participant’s Deferred Compensation Account from one Performance Option to any other Performance Option,

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the Company may charge such Account with an amount not to exceed 5% of the amount so reallocated. The amount of the charge shall be determined by the Company in its discretion and may vary depending on the Performance Options from which and into which the Account is being reallocated.

(vi) In addition, the returns attributable to a Deferred Compensation Account shall be subject to the following adjustments:

(A) Returns attributable to any Performance Option other than the Phantom Stock Option shall be reduced to reflect the amount that a corporate taxpayer in the highest tax bracket for federal corporate tax purposes would pay on the interests, dividends, distribution or similar items of income that it would receive if it had invested in the commercial paper, investment fund, index or other vehicle by reference to which the Performance Option is defined for the period of time, and in the same amounts, that the relevant Deferred Compensation Account was deemed allocated to such Performance Option.

(B) Upon any change in the deemed allocation of a Participant’s Deferred Compensation Account among the Performance Options then available, the Account shall be charged with the amount (if any) (the “Deemed Capital Gain Tax Charge”) of capital gains tax that a corporate taxpayer in the highest bracket for federal corporate tax purposes would pay upon the amount of gain it would recognize had it invested in the investment fund, index or other vehicle by reference to which the Performance Option is defined for the period of time, and in the same amounts, that the relevant Deferred Compensation Account was deemed allocated to such Performance Option. No credit shall be made to an Account for any loss that would be recognized by a corporate taxpayer that had invested in such Performance Option for such period and in such amount.

The amount of the adjustments described in this subparagrpah (vi) shall be determined by the Company in its discretion. The Company shall use its best efforts to apply adjustments on a consistent basis to all Participants who invest in any particular Performance Option.

(d) Manner of Payment of Deferred Benefit. All payments of Deferred Benefits under the Plan will be in cash. The Company shall pay a Participant’s Deferred Benefit either in a single lump sum or in a series of installments, as the Committee in its sole discretion shall determine, provided, however, that if the Committee elects to pay a Participant’s Deferred Benefit in a series of installments, such installments shall be paid no more frequently than quarterly and the Deferred Benefit must be distributed over a period not exceeding five years. The Committee may, but shall not be required to, consult with the Participant prior to determining the manner of payment of such Participant’s Deferred Benefit. If the Committee elects to pay a Participant’s Deferred Benefit in a series of installments, the relative size of such installments shall be determined by the Committee in its discretion, and such installments need not be in equal amounts or equal percentages of such Benefit. The unpaid portion of a Participant’s Deferred Benefit shall continue to be credited with earnings as provided in Section 6(c) until paid.

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(e) Commencement of Payment of Deferred Benefit. For purposes of this Agreement a “Conversion Date” means the earliest to occur of:

(i)(A) termination of service as an Outside Director (unless upon such termination of service the Participant becomes an employee of the Company or any Subsidiary, in which case the following clause (B) shall apply), and (B) termination of employment with the Company and its Subsidiaries (unless upon such termination of employment the Participant becomes an Outside Director, in which case the foregoing clause (A) shall apply);

(ii) the date specified in the Deferral Election Form executed by the Participant; or

(iii) the Participant’s death.

Notwithstanding any other term or provision of this Plan, upon the occurrence of a Conversion Date, any portion of a Participant’s Deferred Compensation Account that is allocated either to the Phantom Unit Option or to any Performance Option other than the Cash Deferral Option will be converted into the Cash Deferral Option based upon (X) in the case of amounts allocated to the Phantom Unit Option, the Fair Market Value of the Common Stock as of the Conversion Date and (Y) in the case of any Performance Option other than the Phantom Stock Option, the net asset value or other relevant valuation measure of the investment fund, index or other vehicle by reference to which the Performance Option is defined, determined as of the Conversion Date or, if such net asset value or other valuation information is not available as of the Conversion Date, as of the latest date preceding the Conversion Date for which the same is generally available. The amount credited to the Cash Deferral Option as a result of such conversion shall, in the case of conversions from any Performance Option other than the Phantom Stock Option, be subject to the Deemed Capital Gain Tax Charge as described in Section 6(c) above. Following conversion, amounts so credited to the Cash Deferral Option will be credited with interest equivalents as provided in Section 6(c)(i). Except as provided in Section 6(f), a Participant’s Deferred Benefit shall be paid (if payable in a lump sum), or commence to be paid (if payable in a series of installments), to the Participant as soon as practicable (but in no event more than 60 days) after the Conversion Date.

(f) Death. In the event of a Participant’s death, the Participant’s entire Deferred Benefit (including any unpaid portion thereof corresponding to installments not yet paid at the time of death), to the extent not distributed earlier pursuant to Section 6(e), will be distributed in a lump sum to the Participant’s Beneficiary or Beneficiaries (or, in the absence of any Beneficiary, to the Participant’s estate) on a date, selected by the Committee, no more than six months after the Participant’s date of death.

(g) Statements. The Company will furnish each Participant with a statement setting forth the value of the Participant’s Deferred Compensation Account as of the end of each calendar year and all credits to and payments from the Deferred Compensation Account during such year. Such statement will be furnished no later than 60 days after the end of each calendar year.

Ambac Financial Group, Inc.

Deferred Compensation Plan for Outside Directors

Page 10 of 13

7. Designation of Beneficiary

(a) Beneficiary Designations. Each Participant may designate a Beneficiary to receive any Deferred Benefit due under the Plan upon the Participant’s death by executing a Beneficiary Designation Form. A Beneficiary designation is not binding on the Company until the Secretary of the Board receives the Beneficiary Designation Form. If no designation is made or no designated Beneficiary is alive (or in the case of an entity designated as a Beneficiary, in existence) at the time of the Participant’s death, payments due under the Plan will be made to the Participant’s estate.

(b) Change of Beneficiary Designation. A Participant may change an earlier Beneficiary designation by executing a later Beneficiary Designation Form. The execution of a Beneficiary Designation Form revokes and rescinds any prior Beneficiary Designation Form.

8. Amendments

(a) General Power of Committee. Subject to Section 8(b), the Plan may be altered, amended, suspended, or terminated at any time by the Committee in its sole discretion.

(b) When Participants’ Consents Required. Except for a termination of the Plan caused by the Committee’s determination that the laws upon which the Plan is based have changed in a manner that negates the Plan’s objectives, the Committee may not alter, amend, suspend, or terminate the Plan without the consent of any Participant to the extent that such action would result in the distribution to such Participant of amounts then credited to his/her Deferred Compensation Account in any manner other than as provided in the Plan or could reasonably be expected to result in the immediate taxation to such Participant of Deferred Benefits.

9. Employer’s Obligation

This Plan is unfunded. A Deferred Compensation Account represents at all times an unfunded and unsecured contractual obligation of the Company. Each Participant or Beneficiary will be an unsecured creditor of the Company. Amounts payable under the Plan will be satisfied solely out of the general assets of the Company subject to the claims of the Company’s creditors. No Participant, Beneficiary or any other person shall have any interest in any fund or in any specific asset of the Company by reason of any amount credited to him/her hereunder, nor shall any Participant, Beneficiary or any other person have any right to receive any distribution under the Plan except as, and to the extent, expressly provided in the Plan. The Company will not segregate any funds or assets for Deferred Benefits or issue any notes or security for the payment of any Deferred Benefits. Any reserve or other asset that the Company

Ambac Financial Group, Inc.

Deferred Compensation Plan for Outside Directors

Page 11 of 13

may establish or acquire to assure itself of the funds to provide benefits under the Plan shall not serve in any way as security to any Participant, Beneficiary or other person for the performance of the Company under the Plan.

10. No Control by Participant

A Participant shall have no control over his Deferred Compensation Account except for (i) designating initial allocation among Performance Options and subsequently revising such allocation, in all cases to the extent permitted by the Plan, (ii) designating the date of initial distribution of benefits on his Deferral Election Form (which designation shall be subject to the terms and conditions of the Plan, including without limitation Section 6) and (iii) designating his or her Beneficiary on a Beneficiary Designation Form.

11. Restrictions on Transfer

The Company shall pay all amounts payable under the Plan only to the Participant or Beneficiary designated under the Plan to receive such amounts. Neither a Participant nor his Beneficiary shall have any right to anticipate, alienate, sell, transfer, assign, pledge, encumber or change any benefits to which he may become entitled under the Plan, and any attempt to do so shall be void. A Deferred Benefit shall not be subject to attachment, execution by levy, garnishment, or other legal or equitable process for a Participant’s or Beneficiary’s debts or other obligations.

12. Election and Revocation Notices

Notices of elections or revocations of elections under the Plan must be in writing. A notice of election or revocation of election will be deemed delivered to the Secretary of the Board on the date it is (i) delivered personally to the Secretary of the Board at One State Street Plaza, New York, New York 10004 (or at such other address as the Company may from time to time designate as the address for elections and revocations of elections under the Plan), (ii) mailed by registered mail or certified mail to the Secretary of the Board at such address or (iii) sent by facsimile transmission to the Secretary of the Board at 212-208-3558 (or such other facsimile transmission number as the Company may designate from time to time for elections and revocations of elections under the Plan), provided that an original signed election or revocation of election is received by the Secretary of the Board no later than 10 business days after such transmission.

13. Waivers

The waiver of a breach of any provision in the Plan shall not operate as and may not be construed as a waiver of any later breach.

Ambac Financial Group, Inc.

Deferred Compensation Plan for Outside Directors

Page 12 of 13

14. Governing Law

The Plan shall be construed in accordance with and governed by the laws of the State of New York.

15. Effective Date

The Plan shall be effective as of December 1, 1993 and Deferral Elections may be made beginning with Eligible Compensation earned during the year beginning January 1, 1994.

16. Construction

The headings in the Plan have been inserted for convenience of reference only and are to be ignored in any construction of the Plan’s provisions. If a provision of the Plan is not valid or enforceable, that fact shall in no way affect the validity or enforceability of any other Provision. Use of one gender includes the other, and the singular and plural include each other. The provisions of the Plan are binding on the Company, each Participating Subsidiary and their respective successors or assigns, and on the Participants, their Beneficiaries, heirs, and personal representatives.

17. Tax Withholding

The Company shall have the right, in connection with any Deferral Election, (i) to require the Participant to remit to the Company an amount sufficient to satisfy any Federal, state or local tax withholding requirements, (ii) to withhold an amount necessary to satisfy such requirements from other cash compensation owed to the Participant or (iii) to reduce the amount of Director Fees deferred pursuant to the Plan in order to ensure that all such requirements are satisfied. The Company shall also have the right to deduct from all cash payments made pursuant to the Plan any Federal, state or local taxes required to be withheld with respect to such payments.

18. No Right to Reelection or Continued Employment

Nothing in the Plan shall be deemed to create any obligation on the part of the Board to nominate any of its members for reelection by the Company’s stockholders, nor confer upon any Outside Director the right to remain a member of the Board for any period of time, or at any particular rate of compensation.

Ambac Financial Group, Inc.

Deferred Compensation Plan for Outside Directors

Page 13 of 13

19. No Stockholder Rights

The crediting of Phantom Stock Units to a Participant’s Deferred Compensation Account shall not confer on the Participant any rights as a stockholder of the Company, nor shall such Units confer on any Participant any right to receive stock of the Company in settlement thereof.

20. Adjustment of and Changes in Shares

In the event of any merger, consolidation, recapitalization, reclassification, stock dividend, special cash dividend or other change in corporate structure affecting the Common Stock, the Committee shall make such adjustments, if any, as it deems appropriate in the number of Phantom Stock Units credited to a Participant’s Deferred Compensation Account. The foregoing adjustments shall be decided by the Committee in its discretion.

21. About the Plan

The Deferred Compensation Plan for Outside Directors and Senior Officers was established as of December 1, 1993 by Ambac Inc. In 1997 Ambac Inc. became Ambac Financial Group, Inc. The Plan was amended on October 28, 1998 in order to offer its participants more investment options.

The Plan was amended and restated, effective October 26, 1999 to provide that this Plan be available only to Outside Directors. Senior Officers no longer participate in this Plan as a new deferred plan has been adopted for them.

EX-31.1

EXHIBIT 31.1

Ambac Financial Group, Inc.

Certifications

I, Robert J. Genader, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Ambac Financial Group, Inc;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - -15(e) and 15d – 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

By:	/s/ Robert J. Genader
	Robert J. Genader
	Chairman, President and Chief Executive Officer

Date: August 9, 2007

EX-31.2

EXHIBIT 31.2

Ambac Financial Group, Inc.

Certifications

I, Sean T. Leonard, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Ambac Financial Group, Inc;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - -15(e) and 15d – 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

By:	/s/ Sean T. Leonard
	Sean T. Leonard
	Senior Vice President and Chief Financial Officer

Date: August 9, 2007

EX-32.1

EXHIBIT 32.1

Certification of CEO Pursuant to

18 U.S.C. Section 1350,

as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Ambac Financial Group, Inc. (the “Company”) for the period ended June 30, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Robert J. Genader, as Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Robert J. Genader
Name:	Robert J. Genader
Title:	Chairman, President and Chief Executive Officer
Date:	August 9, 2007

EX-32.2

EXHIBIT 32.2

Certification of CFO Pursuant to

18 U.S.C. Section 1350,

as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Ambac Financial Group, Inc. (the “Company”) for the period ended June 30, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Sean T. Leonard, as Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Sean T. Leonard
Name:	Sean T. Leonard
Title:	Senior Vice President and Chief Financial Officer
Date:	August 9, 2007

EX-99.05

EXHIBIT 99.05

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

(a wholly owned subsidiary of Ambac Financial Group, Inc.)

Consolidated Unaudited Financial Statements

As of June 30, 2007 and December 31, 2006

and for the Three and Six Months Ended June 30, 2007 and 2006

Ambac Assurance Corporation and Subsidiaries

Consolidated Balance Sheets

June 30, 2007 and December 31, 2006

(Dollars in Thousands Except Share Data)

	June 30, 2007		December 31, 2006
	(unaudited)
ASSETS
Investments:
Fixed income securities, at fair value (amortized cost of $10,087,589 in 2007 and $9,669,972 in 2006)	$	10,118,102	$	9,877,920
Short-term investments, at cost (approximates fair value)		187,651		232,179
Other (cost of $38,070 in 2007 and $12,845 in 2006)		38,872		13,397
Total investments		10,344,625		10,123,496
Cash		34,500		23,595
Securities purchased under agreements to resell		155,000		95,000
Receivable for securities sold		48,310		2,382
Investment income due and accrued		137,978		131,538
Reinsurance recoverable on paid and unpaid losses		4,793		3,921
Prepaid reinsurance		322,914		315,498
Deferred acquisition costs		271,235		252,115
Derivative assets		939,363		1,018,886
Loans		272,511		11,291
Other assets		92,520		83,841
Total assets	$	12,623,749	$	12,061,563
LIABILITIES AND STOCKHOLDER’S EQUITY
Liabilities:
Unearned premiums	$	3,068,398	$	3,048,039
Loss and loss expense reserve		255,825		220,074
Ceded reinsurance balances payable		19,194		20,080
Obligations under payment agreements		248,225		248,415
Long-term debt		275,490		—
Deferred income taxes		136,886		208,053
Current income taxes		62,101		61,342
Payable for securities purchased		134,850		95,973
Derivative liabilities		904,005		920,399
Other liabilities		286,999		246,882
Total liabilities		5,391,973		5,069,257
Stockholder’s equity:
Preferred stock, par value $1,000 per share; authorized shares - 285,000; issued and outstanding shares - none		—		—
Common stock, par value $2.50 per share; authorized shares - 40,000,000; issued and outstanding shares - 32,800,000 at June 30, 2007 and December 31, 2006		82,000		82,000
Additional paid-in capital		1,545,459		1,508,828
Accumulated other comprehensive income		28,510		141,927
Retained earnings		5,575,807		5,259,551
Total stockholder’s equity		7,231,776		6,992,306
Total liabilities and stockholder’s equity	$	12,623,749	$	12,061,563

See accompanying Notes to Consolidated Unaudited Financial Statements.

1

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

For The Three and Six Months Ended June 30, 2007 and 2006

(Dollars in Thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
Revenues:
Financial Guarantee:
Gross premiums written	$	263,705		$	314,210		$	516,160		$	533,984
Ceded premiums written		(28,437	)		(57,747	)		(57,921	)		(48,990	)
Net premiums written	$	235,268		$	256,463		$	458,239		$	484,994
Net premiums earned	$	226,547		$	212,548		$	445,904		$	408,496
Other credit enhancement fees		16,661			13,494			31,545			27,024
Net premiums earned and other credit enhancement fees		243,208			226,042			477,449			435,520
Net investment income		113,201			104,454			225,265			206,174
Net realized investment gains		881			1,892			1,321			1,513
Net mark-to-market (losses) gains on credit derivative contracts		(56,867	)		5,381			(61,991	)		7,334
Other income		1,997			3,444			5,193			31,458
Financial Services:
Investment income		3,011			3,095			6,023			6,104
Derivative products		1,675			5,375			8,883			15,394
Total revenues		307,106			349,683			662,143			703,497
Expenses:
Financial Guarantee:
Loss and loss expenses		17,096			12,822			28,518			12,949
Underwriting and operating expenses		33,438			31,865			69,814			69,723
Financial Services:
Interest on payment agreements		2,547			2,342			5,011			4,409
Derivative products		1,424			1,550			2,719			3,196
Total expenses		54,505			48,579			106,062			90,277
Income before income taxes		252,601			301,104			556,081			613,220
Provision for income taxes		63,241			82,121			144,725			169,071
Net income	$	189,360		$	218,983		$	411,356		$	444,149

See accompanying Notes to Consolidated Unaudited Financial Statements.

2

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Stockholder’s Equity

(Unaudited)

For The Six Months Ended June 30, 2007 and 2006

(Dollars in Thousands)

	2007						2006
Retained Earnings:
Balance at January 1	$	5,259,551					$	4,509,653
Net income		411,356		$	411,356			444,149		$	444,149
Dividends declared—common stock		(95,100	)					(68,000	)
Dividends on restricted stock units		—						(372	)
Balance at June 30	$	5,575,807					$	4,885,430
Accumulated Other Comprehensive (Loss) Income:
Balance at January 1	$	141,927					$	136,897
Unrealized losses on securities, ($177,179) and ($201,422), pre-tax, in 2007 and 2006, respectively (1)					(115,166	)					(130,924	)
Foreign currency translation gain					1,749						4,319
Other comprehensive loss		(113,417	)		(113,417	)		(126,605	)		(126,605	)
Comprehensive income				$	297,939					$	317,544
Balance at June 30	$	28,510					$	10,292
Preferred Stock:
Balance at January 1 and June 30	$	—					$	—
Common Stock:
Balance at January 1 and June 30	$	82,000					$	82,000
Additional Paid-in Capital:
Balance at January 1	$	1,508,828					$	1,453,060
Capital issuance costs		(1,685	)					(1,865	)
Employee benefit plans		30,084						11,300
Excess tax benefit related to share-based compensation		8,232						4,465
Balance at June 30	$	1,545,459					$	1,466,960
Total Stockholder’s Equity at June 30	$	7,231,776					$	6,444,682
(1) Disclosure of reclassification amount:
Unrealized holding losses arising during period	$	(114,476	)				$	(131,232	)
Less: reclassification adjustment for net securities gains (losses) included in net income		690						(308	)
Net unrealized losses on securities	$	(115,166	)				$	(130,924	)

See accompanying Notes to Consolidated Unaudited Financial Statements.

3

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

For The Six Months Ended June 30, 2007 and 2006

(Dollars in Thousands)

	Six Months Ended June 30,
	2007			2006
Cash flows from operating activities:
Net income	$	411,356		$	444,149
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,347			1,379
Amortization of bond premium and discount		12,330			11,654
Share based compensation		23,024			12,573
Current income taxes		759			50,197
Deferred income taxes		(10,100	)		(10,844	)
Deferred acquisition costs		(12,672	)		(9,003	)
Unearned premiums, net		12,943			77,996
Loss and loss expenses		34,879			(14,662	)
Ceded reinsurance balances payable		(886	)		14,334
Change in trading account assets		(25,195	)		—
Net mark-to-market losses (gains)		61,991			(7,334	)
Net realized investment gains		(1,321	)		(1,513	)
Other, net		(52,869	)		18,003
Net cash provided by operating activities		455,586			586,929
Cash flows from investing activities:
Proceeds from sales of bonds		2,189			515,803
Proceeds from maturities of bonds		307,761			201,347
Purchases of bonds		(742,416	)		(1,431,078	)
Change in short-term investments		44,528			202,192
Loans		(261,220	)		(2,809	)
Securities purchased under agreements to resell		(60,000	)		(48,000	)
Other, net		38			982
Net cash used in investing activities		(709,120	)		(561,563	)
Cash flows from financing activities:
Dividends paid		(95,100	)		(68,000	)
Capital issuance costs		(1,685	)		(1,865	)
Securities sold under agreements to repurchase		—			25,000
Proceeds from issuance of long-term debt		275,490			—
Payment agreements		(190	)		(165	)
Net cash collateral received		77,692			14,191
Excess tax benefit related to share-based compensation		8,232			4,465
Net cash provided by (used in) financing activities		264,439			(26,374	)
Net cash flow		10,905			(1,008	)
Cash at January 1		23,595			20,469
Cash at June 30	$	34,500		$	19,461
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes	$	145,982		$	125,235
Interest on payment agreements	$	4,841		$	4,007

See accompanying Notes to Consolidated Unaudited Financial Statements.

4

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands)

(1) Background and Basis of Presentation

Ambac Assurance and subsidiaries, headquartered in New York City, provides financial guarantee products and other financial services to clients in both the public and private sectors around the world. Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch, Inc. Financial guarantee insurance provides an unconditional and irrevocable guarantee that protects the holder of a fixed income obligation against non-payment of principal and interest when due. Essentially, Ambac Assurance makes payment if the obligor responsible for making payments fails to do so. A bond guaranteed by Ambac Assurance receives triple-A ratings, typically resulting in lower financing costs for the issuer and the guarantee generally makes the issue more marketable, both in the primary and secondary markets. Ambac Assurance’s financial strength ratings are an essential part of Ambac Assurance’s ability to provide credit enhancement and any reduction in these ratings could have a materially adverse affect on Ambac Assurance’s ability to compete in the financial guarantee business. Ambac Assurance provides financial guarantees for bond issues and other forms of debt financing. As an alternative to financial guarantee insurance, credit protection relating to a particular pool of assets, security or issuer can be provided through a credit derivative. Ambac provides credit protection in the global markets in credit derivative form. Ambac Assurance is a wholly owned subsidiary of Ambac Financial Group, Inc, a holding company whose subsidiaries provide financial guarantee products and other financial services to clients in both the public and private sectors around the world. As of June 30, 2007, Ambac Assurance’s net guarantees in force (principal and interest) were $849,061,604.

The accompanying consolidated unaudited interim financial statements have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities. Actual results could differ from those estimates. The results of operations for the six months ended June 30, 2007 may not be indicative of the results that may be expected for the full year ending December 31, 2007. These consolidated financial statements and notes should be read in conjunction with the financial statements and notes included in (i) the audited consolidated financial statements of Ambac Assurance and subsidiaries as of December 31, 2006 and 2005, and for each of the years in the three-year period ended December 31, 2006, which was filed with the Securities and Exchange Commission on March 1, 2007 as Exhibit 99.01 to Ambac Financial Group Inc.’s Form 10-K and (ii) the unaudited consolidated financial statements of Ambac Assurance and subsidiaries as of March 31, 2007, which was filed with the SEC on May 10, 2007 as Exhibit 99.03 to Ambac Financial Group’s 10-Q for the quarterly period ended March 31, 2007.

The consolidated financial statements include the accounts of Ambac Assurance and all other entities in which Ambac Assurance has a controlling financial interest. All significant intercompany balances have been eliminated. The usual condition for a controlling financial

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(Dollars in thousands)

interest is ownership of a majority of the voting interests of an entity. However, a controlling financial interest may also exist in entities, such as variable interest entities (“VIEs”), through arrangements that do not involve controlling voting interests.

Certain reclassifications have been made to prior period’s amounts to conform to the current period’s presentation.

(3) Net Premiums Earned

Gross premiums are received either upfront (typical of public finance obligations), or in installments (typical of structured finance obligations). Up-front insurance premiums written are received for an entire bond issue, which may contain several maturities; and are recorded as unearned premiums. The premium is allocated to each bond maturity proportionately based on total principal amount guaranteed and is recognized as premiums on a straight-line basis over the term of each maturity. Installment insurance premiums written are recognized as premiums earned over each installment period, typically one year or less, on a straight-line basis. Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. When an issue insured by Ambac Assurance has been refunded or called, the remaining unrecognized premium (net of refunding credits, if any) is recognized at that time.

Premiums ceded to reinsurers reduce the amount of net premiums earned by Ambac Assurance from its financial guarantee insurance policies. For both up-front and installment premiums, ceded premiums written are primarily recognized in earnings in proportion to and at the same time the related gross premium revenue is recognized. Prepaid reinsurance represents the portion of premiums ceded to reinsurers relating to unearned premiums ceded under reinsurance contracts. As discussed in footnote 7, the accounting for premiums earned is subject to change.

(3) Loss and Loss Expenses

The loss reserve policy for financial guarantee insurance discussed in this footnote relates only to Ambac Assurance’s non-derivative insurance business. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. In most instances, claim payments are forecasted in advance of issuer default as a result of active surveillance of the insured book of business and observation of deterioration in the obligor’s credit standing. Based upon Ambac Assurance’s experience, claim payments become probable and estimable once the issuer’s credit profile has migrated to certain impaired credit levels. The trustee, on behalf of the insured party, named beneficiary, or custodian has the right to make a claim under Ambac Assurance’s financial guarantee insurance policy at the first scheduled debt service date of the defaulted obligation. As discussed in the last paragraph of this Note, the accounting for credit loss reserves is subject to change.

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Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

The liability for losses and loss expenses consists of active credit and case basis credit reserves. Active credit reserves are for probable and estimable losses due to credit deterioration on insured credits that have not yet defaulted or been reported and are reflected on an undiscounted basis as of the reporting date. The establishment of reserves for exposures that have not yet defaulted is a common practice in the financial guarantee industry. However, Ambac Assurance is aware that there are differences in the specific methodologies applied by other financial guarantors in establishing such reserves. Ambac Assurance’s active credit reserve is based on management’s on-going review of the non-derivative financial guarantee credit portfolio. Active surveillance of the insured portfolio enables Ambac Assurance’s Surveillance Group to track credit migration of insured obligations from period to period and prepare an adversely classified credit listing. The active credit reserve is established only for adversely classified credits. The criteria for an exposure to be included on the adversely classified credit listing includes the deterioration in an issuer’s financial condition, underperformance of the underlying collateral (for collateral dependent transactions such as mortgage-backed securitizations), problems with the servicer of the underlying collateral and other adverse economic events or trends. The servicer of the underlying collateral of an insured securitization transaction is a consideration in assessing credit quality because the servicer’s performance can directly impact the performance of the related issue. For example, a servicer of a mortgage-backed securitization that does not remain current in its collection efforts could cause an increase in the delinquency and potential default of the underlying obligation.

The active credit reserve is established through a process that begins with estimates of probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac Assurance’s internal system of credit ratings, which are analogous to the risk ratings of the major rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) the net par outstanding on the adversely classified credit. The loss severities and default information are based on rating agency information and are specific to each bond type and are established and approved by Ambac Assurance’s Portfolio Risk Management Committee. The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac Assurance. For certain adversely classified credit exposures, Ambac Assurance’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities applied to adversely classified credits can include various actions by Ambac Assurance. The most common actions include obtaining detailed appraisal information on collateral, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac Assurance uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical approach discussed above. Senior management meets at least quarterly with the Surveillance Group to review the status of their work to determine the adequacy of Ambac Assurance’s loss reserves and make any necessary adjustments. Active credit reserves were $203,707 and $172,644 at June 30, 2007 and December 31, 2006, respectively. The active credit reserves at June 30, 2007 and December

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(Dollars in thousands)

31, 2006 were comprised of 46 credits with net par of $3,223,583 and 55 credits with net par outstanding of $3,830,759, respectively. Included in the calculation of active credit reserves at June 30, 2007 and December 31, 2006 was the consideration of $11,875 and $6,859, respectively, of reinsurance which would be due to Ambac Assurance from reinsurers, upon default of the insured obligation.

Case basis credit reserves are for losses on insured obligations that have defaulted. We believe our definition of case basis credit reserves differs from other financial guarantee industry participants. Upon the occurrence of a payment default, the related active credit reserve is transferred to case basis credit reserve. Additional provisions for losses upon further credit deterioration of a case basis exposure are initially recorded through the active credit reserve and subsequently transferred to case basis credit reserves. Our case reserves represent the present value of anticipated loss and loss expense payments expected over the estimated period of default. Loss and loss expenses consider anticipated defaulted debt service payments, estimated expenses associated with settling the claims and estimated recoveries under collateral and subrogation rights. The estimate does not consider future installment premium receipts, as the likelihood of such receipts is remote. Ambac Assurance discounts these estimated net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio.

Case basis credit reserves were $52,118 and $47,430 at June 30, 2007 and December 31, 2006, respectively. The discount rate applied to case basis credit reserves was 4.50% at June 30, 2007 and December 31, 2006. The case basis credit reserves at June 30, 2007 and December 31, 2006 were comprised of 7 credits, with net par outstanding of $495,182 and $668,440, respectively. Additionally, we have reinsurance recoverables on case basis credit reserves of $4,857 and $4,972 at June 30, 2007 and December 31, 2006, respectively.

Ambac Assurance provides information on the classification of its loss reserve between active credit reserve and case basis credit reserve for the purpose of disclosing the components of the total reserve that relate to exposures that have not yet defaulted and those that have defaulted. The total reserve (active credit and case basis) was $255,825 and $220,074 at June 30, 2007 and December 31, 2006, respectively. Due to the relatively small number and large size of certain insured obligations comprising the active and case basis credit reserves, improvements or further deterioration in any one credit may significantly impact our loss provision in a given period. The provision for losses and loss expenses in the accompanying Consolidated Statements of Operations represents the expense recorded to bring the total reserve to a level determined by management to be adequate for losses inherent in the non-derivative financial guarantee insurance portfolio. Ambac Assurance’s management believes that the reserves for losses and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.

Our liabilities for credit losses are based in part on the short-duration accounting guidance in SFAS 60, “Accounting and Reporting by Insurance Enterprises.” The trustee (on behalf of the insured party), named beneficiary or custodian has a right to a claim payment under the financial

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(Dollars in thousands)

guarantee insurance policy at the date of the first scheduled debt service payment of a defaulted security in the amount equal to the payment shortfall. We believe a loss event occurs for financial guarantee insurance products at the time the issuers’ financial condition deteriorates to an impaired credit status rather than at the time the insured party has a right to a claim payment. Because of this belief and the ambiguities discussed below in the application of SFAS 60 to the financial guarantee industry, Ambac Assurance does not believe that SFAS 60 alone provides sufficient guidance. As a result, Ambac Assurance supplements the guidance in SFAS 60 with the guidance in SFAS 5, “Accounting for Contingencies,” which calls for a loss to be accrued if it is probable that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. Ambac Assurance also relies by analogy on EITF Issue 85-20, “Recognition of Fees for Guaranteeing a Loan,” which states that a guarantor should perform an ongoing assessment of the probability of loss to determine if a liability (and a loss) should be recognized under SFAS 5.

In management’s view, the accounting guidance noted above does not comprehensively address the attributes of financial guarantee insurance contracts, primarily due to the fact that SFAS 60 was developed prior to the maturity of the financial guarantee industry. Financial guarantee contracts have elements of long-duration insurance contracts in that they are generally irrevocable and extend over a period of time that may be 30 years or more but are considered and reported for regulatory purposes as property and casualty insurance, normally considered short-duration contracts. The short-duration and long-duration classifications have different methods of accounting for premium revenue, deferred acquisition costs and contract liability recognition.

Ambac Assurance is aware that there are certain differences regarding the measurement of liabilities for credit losses among participants in the financial guarantee industry. Difficulties in applying the existing insurance accounting literature; such as the classification of the insurance contracts as either short-duration or long-duration to the attributes of financial guarantee insurance, different measurement models and assumptions utilized, regulatory guidance provided to certain entities, and the existence of accounting literature providing guidance with respect to liability recognition for loan guarantees are the reasons for differences among the industry participants.

In January and February of 2005, the Securities and Exchange Commission staff discussed with the financial guarantee industry participants differences in loss reserve recognition practices among those participants. In June 2005, the Financial Accounting Standards Board (“FASB”) added a project to its agenda to consider the accounting by financial guarantee insurers for claims liability recognition, premium recognition and deferred acquisition costs. The proposed guidance was issued on April 18, 2007 and the final guidance is expected to be issued in the first quarter of 2008.

(4) Income Taxes

On January 1, 2007, Ambac Assurance adopted the provisions of FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes”, an interpretation of SFAS 109, which provides a framework to determine the appropriate level of tax reserves for uncertain tax

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(Dollars in thousands)

positions. FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition. Ambac Assurance’s liability for unrecognized tax benefits was not impacted as a result of the adoption of FIN 48.

Ambac Financial Group files a consolidated Federal income tax return with its subsidiaries. Ambac Financial Group and its subsidiaries also file separate or combined income tax returns in various states, local and foreign jurisdictions.

The following are the major jurisdictions in which Ambac Assurance and its subsidiaries operate and the earliest tax years subject to examination:

Jurisdiction	Tax Year
United States	2001
United Kingdom	2005

As of June 30, 2007 and December 31, 2006, the liability for unrecognized tax benefits is approximately $60,510 and $54,100, respectively. Included in these balances at June 30, 2007 and December 31, 2006 are $36,710 and $30,300, respectively, of unrecognized tax benefits that, if recognized, would affect the effective tax rate. Over the next 12 months, Ambac Financial Group estimates it may decrease federal tax reserves by approximately $11,200 for issues that may no longer warrant a tax reserve after an expected settlement for the years 2001 through 2004.

Ambac Assurance accrues interest and penalties related to unrecognized tax benefits in the provision for income taxes. During the three months ended June 30, 2007 and 2006, Ambac Financial Group recognized approximately $780 and $400, respectively, in interest. Ambac Financial Group had approximately $3,610 and $2,200 for the payment of interest accrued at June 30, 2007 and December 31, 2006, respectively.

(5) Special Purpose and Variable Interest Entities

Ambac Financial Group has involvement with special purpose entities, including VIEs in the following ways. First, Ambac Assurance is a provider of financial guarantee insurance for various debt obligations. Second, Ambac Financial Group has sponsored two special purpose entities that issue medium-term notes (“MTNs”) to fund the purchase of certain financial assets. As discussed in detail below, these Ambac Financial Group-sponsored special purpose entities are considered Qualifying Special Purpose Entities (“QSPEs”). Lastly, Ambac Assurance is an investor in asset-backed securities issued by VIEs, and, in one transaction, has a beneficial interest in a VIE that purchases fixed rate municipal bonds with proceeds from the issuance of floating rate short term beneficial interests as discussed in detail below.

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Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

Financial Guarantees:

Ambac Assurance provides financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs. Ambac Assurance’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structure provides certain financial protection to Ambac Assurance. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread. In the case of over-collateralization, (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by Ambac Assurance), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the structured finance obligations that have been guaranteed by Ambac Assurance. In the case of first loss, the financial guarantee insurance policy only covers a senior layer of losses on assets held or debt issued by special purpose entities, including VIEs. The first loss with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate interest cash flows that are in excess of the interest payments on the related debt; such excess cash flow is applied to redeem debt, thus creating over-collateralization.

As of June 30, 2007, Ambac Assurance is the primary beneficiary and therefore consolidated a VIE under one transaction as a result of providing a financial guaranty. The VIE is a bankruptcy remote special purpose financing entity created by the issuer of debt securities to facilitate the sale of notes guaranteed by Ambac Assurance. Ambac Assurance is not primarily liable for the debt obligations of the VIE. Ambac Assurance would only be required to make payments on these debt obligations in the event that the issuer defaults on any principal or interest due. Additionally, Ambac Assurance’s creditors do not have rights with regard to the assets of the VIE.

Proceeds from the note issuance of the VIE, were used to extend loans to universities in the United Kingdom. The financial reports of this VIE are prepared by an outside trustee and are not available within the time constraints Ambac Assurance requires to ensure the financial accuracy of the operating results. As such, the financial results of the VIE will be consolidated on a one quarter lag. Total long-term debt outstanding under this note issuance was $275,490 with a maturity date of December 7, 2047 and a fixed rate of interest of 5.32% at June 30, 2007. Ambac Assurance is subject to potential consolidation of an additional $743,000 of assets and liabilities in connection with future utilization of the VIE.

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(Dollars in thousands)

The following table provides supplemental information about the combined assets and liabilities associated with the VIE discussed above. The assets and liabilities of the VIE are consolidated into the respective Balance Sheet captions.

	At June 30, 2007		At December 31, 2006
Assets:
Cash	$	9,027	$	—
Investment income due and accrued		359		—
Loans		261,047		—
Other assets		5,057		—
Total assets	$	275,490		—
Liabilities:
Long-term debt	$	275,490	$	—
Total liabilities		275,490		—
Stockholders’ equity:		—		—
Total liabilities and stockholders’ equity	$	275,490	$	—

Qualified Special Purpose Entities:

Ambac Financial Group has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). QSPEs are not subject to the requirements of FIN 46(R) and accordingly are not consolidated in Ambac Financial Group’s or Ambac Assurance’s financial statements. The QSPEs are legal entities that are demonstrably distinct from Ambac Financial Group. Ambac Financial Group, its affiliates or its agents cannot unilaterally dissolve the QSPEs. The QSPEs permitted activities are limited to those outlined below.

As of June 30, 2007, there have been 15 individual transactions processed through the QSPEs of which 10 are outstanding. In each case, Ambac Financial Group sold fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPEs and the absence of any agreement or obligation for Ambac Financial Group to repurchase or redeem assets of the QSPEs. Additionally, Ambac Financial Group’s creditors do not have any rights with regards to the assets of the QSPEs. The purchase by the QSPEs is financed through the issuance of MTNs, which are collateralized by the purchased assets. Derivative contracts (interest rate and currency swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are contractually limited to purchasing assets from Ambac Financial Group, issuing MTNs to fund such purchase, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued and/or the related derivative contracts. As of June 30, 2007, Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the QSPEs.

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Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

Pursuant to the terms of Ambac Assurance’s insurance policy, insurance premiums are paid to Ambac Assurance by the QSPEs and are earned in a manner consistent with other insurance policies, over the risk period. Any losses incurred would be included in Ambac Assurance’s Consolidated Statements of Operations. Under the terms of an Administrative Agency Agreement, Ambac Financial Group provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.

Assets sold to the QSPEs during the six months ended June 30, 2007 and the year ended December 31, 2006 were $0 and $450,000, respectively. No gains or losses were recognized on the sales in either period. As of June 30, 2007, the estimated fair value of financial assets, MTN liabilities and derivative hedge assets of the QSPEs was $1,941,079, $2,005,069 and $39,008, respectively. When market quotes are not available, fair values are based on internal valuation models, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $3,173 and $2,572 for the six months ended June 30, 2007 and 2006, respectively. Ambac Financial Group also received fees for providing other services amounting to $126 and $140 for the six months ended June 30, 2007 and 2006, respectively.

VIE Beneficial Interest:

Ambac Assurance owns a beneficial interest in a special purpose entity that meets the definition of a VIE. This entity has issued floating rate beneficial interests to investors and invested the proceeds in fixed rate municipal debt securities. These beneficial interests are directly secured by the related municipal debt securities. Ambac Assurance is the primary beneficiary of this entity as a result of its beneficial interest. The fixed rate municipal debt securities, which are reported as “Investments in fixed income securities, at fair value” on the Consolidated Balance Sheets, were $254,187 and $258,976 as of June 30, 2007 and December 31, 2006, respectively. The beneficial interests issued to third parties, reported as “Obligations under investment and payment agreements” on the Consolidated Balance Sheets, were $248,225 and $248,415 as of June 30, 2007 and December 31, 2006, respectively. Under the terms of these beneficial interests, the investors have the contractual right to redeem their investment at any time, with five business days notice. As of June 30, 2007 and December 31, 2006, the interest rates on these beneficial interests ranged from 3.62% to 3.99% and from 2.95% to 4.01%, respectively.

(6) Segment Information

Ambac Assurance has two reportable segments, as follows: (1) Financial Guarantee, which provides financial guarantees (including credit derivatives) for public finance and structured finance obligations; and (2) Financial Services, which provides payment agreements, interest rate, currency and total return swaps.

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(Dollars in thousands)

Ambac Assurance’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different marketing strategies, personnel skill sets and technology.

Intersegment revenues include the premiums earned under those agreements. Ambac Assurance guarantees swap obligations and receives dividends from its Financial Services subsidiaries. Such premiums are determined as if they were premiums to third parties, that is, at current market prices. Financial Guarantee intersegment revenues included dividends of $0 and $11,000, respectively, from Financial Services, in the three and six months ended June 30, 2006, respectively. There were no intersegment dividends during the six months ended June 30, 2007.

The following tables summarize the financial information by reportable segment as of and for the three and six months ended June 30, 2007 and 2006:

(Dollars in thousands) Three months ended June 30,	Financial Guarantee		Financial Services			Intersegment Eliminations			Consolidated
2007:
Revenues:
External customers	$	302,420	$	4,686		$	—		$	307,106
Intersegment		652		—			(652	)		—
Total revenues	$	303,072	$	4,686		$	(652	)	$	307,106
Income before income taxes:
External customers	$	251,886	$	715		$	—		$	252,601
Intersegment		1,319		(1,319	)		—			—
Total income before income taxes	$	253,205	$	(604	)	$	—		$	252,601
Total assets	$	11,195,476	$	1,428,273		$	—		$	12,623,749
2006:
Revenues:
External customers	$	341,213	$	8,470		$	—		$	349,683
Intersegment		714		—			(714	)		—
Total revenues	$	341,927	$	8,470		$	(714	)	$	349,683
Income before income taxes:
External customers	$	296,526	$	4,578		$	—		$	301,104
Intersegment		1,388		(1,388	)		—			—
Total income before income taxes	$	297,914	$	3,190		$	—		$	301,104
Total assets	$	10,084,983	$	1,160,606		$	—		$	11,245,589

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(Dollars in thousands)

(Dollars in thousands) Six months ended June 30,	Financial Guarantee		Financial Services			Intersegment Eliminations			Consolidated
2007:
Revenues:
External customers	$	647,237	$	14,906		$	—		$	662,143
Intersegment		1,459		—			(1,459	)		—
Total revenues	$	648,696	$	14,906		$	(1,459	)	$	662,143
Income before income taxes:
External customers	$	548,905	$	7,176		$	—		$	556,081
Intersegment		2,793		(2,793	)		—			—
Total income before income	$	551,698	$	4,383		$	—		$	556,081
Identifiable assets	$	11,195,476	$	1,428,273		$	—		$	12,623,749
2006:
Revenues:
External customers	$	681,999	$	21,498		$	—		$	703,497
Intersegment		12,414		—			(12,414	)		—
Total revenues	$	694,413	$	21,498		$	(12,414	)	$	703,497
Income before income taxes:
External customers	$	599,327	$	13,893		$	—		$	613,220
Intersegment		13,762		(2,762	)		(11,000	)		—
Total income before income	$	613,089	$	11,131		$	(11,000	)	$	613,220
Identifiable assets	$	10,084,983	$	1,160,606		$	—		$	11,245,589

The following table summarizes unaffiliated gross premiums written and net premiums earned and other credit enhancement fees included in the financial guarantee segment by location of risk for the three and six months ended June 30, 2007 and 2006:

(Dollars in thousands)	Three Months				Six Months
	Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees		Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees
2007:
United States	$	201,832	$	185,540	$	402,001	$	363,090
United Kingdom		27,571		18,455		45,042		37,017
Other International		34,302		39,213		69,117		77,342
Total	$	263,705	$	243,208	$	516,160	$	477,449
2006:
United States	$	213,823	$	170,945	$	385,629	$	328,598
United Kingdom		57,440		16,735		73,586		32,105
Other International		42,947		38,362		74,769		74,817
Total	$	314,210	$	226,042	$	533,984	$	435,520

(7) Future Application of Accounting Standards

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures

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(Dollars in thousands)

about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In addition, SFAS 157 supersedes certain accounting guidance, which prohibited the recognition of day one gains on certain derivative transactions. With the adoption of SFAS 157, any remaining reserves for day one gains will be reflected as a cumulative effect adjustment to the opening balance of retained earnings. Ambac Assurance is currently evaluating the implications of SFAS 157 on its financial statements.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS 159 permits reporting entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments and not to portions of instruments. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years that begin after November 15, 2007. Ambac Assurance is currently evaluating the implications of SFAS 159 on its financial statements.

On April 18, 2007, the FASB issued an Exposure Draft (“ED”) for a proposed SFAS “Accounting for Financial Guarantee Insurance Contracts”, an interpretation of SFAS 60, “Accounting and Reporting by Insurance Enterprises”. The ED clarifies how SFAS 60 applies to financial guarantee insurance contracts issued by insurance enterprises, including the methodology to account for premium revenue and claim liabilities. The comment period for the ED ended on June 18, 2007 and the final Statement is expected to be issued in the first quarter of 2008. The final Statement shall be applied to existing and future financial guarantee insurance contracts. The cumulative effect of initially applying this final Statement will be recorded as an adjustment to the opening balance of retained earnings for that fiscal year.

In April 2007, the FASB issued FASB Staff Position (“FSP”) FIN 39-1, an amendment of FASB Interpretation No. 39. FSP FIN 39-1 permits fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a liability) to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under the same master netting arrangement. The decision to offset fair value amounts constitutes an accounting policy election by the entity. A reporting entity shall not offset fair value amounts recognized for derivative instruments without offsetting fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007, with earlier application permitted. An entity must recognize the effect of applying FSP FIN 39-1 retrospectively as a change in accounting principle for all financial statement periods presented, unless it is impracticable to do so. Ambac Assurance is currently evaluating the implications of FSP FIN 39-1 on its financial statements.

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